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Welfare Gains from Disinflation in an Economy With Currency Substitution (Para Ikamesinin Oldugu Bir Ekonomide Enflasyonun Dusurulmesinden Kaynaklanan Refah Kazanimlari)

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  • H. Murat Ozbilgin

Abstract

This paper studies welfare gains from disinflation in the presence of currency substitution. A distinctive small open economy model with currency substitution and intermediated working capital is constructed for this objective. It is found that welfare gains from disinflation are higher when the baseline elasticity of substitution between foreign currency and domestic deposits is higher. Indeed the gains from disin?ation can be quite large compared to previous studies especially for moderate rates of inflation if the two assets are highly substitutable under the baseline scenario. After the benchmark economy is specified, the model is used to assess welfare gains from disinflation for a given level of financial development. The model implies that, higher currency substitution is welfare enhancing for high inflation rates but not for moderate and low inflation rates. In other words, currency substitution is not necessarily welfare enhancing.

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Bibliographic Info

Paper provided by Research and Monetary Policy Department, Central Bank of the Republic of Turkey in its series Working Papers with number 1009.

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Date of creation: 2010
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Handle: RePEc:tcb:wpaper:1009

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Keywords: Inflation; welfare; currency substitution; monetary policy;

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  1. Robert E. Lucas, Jr., 2000. "Inflation and Welfare," Econometrica, Econometric Society, vol. 68(2), pages 247-274, March.
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  7. Calvo, Guillermo A., 1985. "Currency substitution and the real exchange rate: the utility maximization approach," Journal of International Money and Finance, Elsevier, vol. 4(2), pages 175-188, June.
  8. Engel, Charles, 1989. "The trade balance and real exchange rate under currency substitution," Journal of International Money and Finance, Elsevier, vol. 8(1), pages 47-58, March.
  9. Özbilgin, H. Murat, 2010. "Financial market participation and the developing country business cycle," Journal of Development Economics, Elsevier, vol. 92(2), pages 125-137, July.
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  11. Uribe, Martin, 1999. "Comparing the welfare costs and initial dynamics of alternative inflation stabilization policies," Journal of Development Economics, Elsevier, vol. 59(2), pages 295-318, August.
  12. Ariel Burstein & Christian Hellwig, 2008. "Welfare Costs of Inflation in a Menu Cost Model," 2008 Meeting Papers 1, Society for Economic Dynamics.
  13. L. Wade, 1988. "Review," Public Choice, Springer, vol. 58(1), pages 99-100, July.
  14. Sturzenegger, Federico, 1997. "Understanding the welfare implications of currency substitution," Journal of Economic Dynamics and Control, Elsevier, vol. 21(2-3), pages 391-416.
  15. Holman, Jill A. & Neanidis, Kyriakos C., 2006. "Financing government expenditures in an open economy," Journal of Economic Dynamics and Control, Elsevier, vol. 30(8), pages 1315-1337, August.
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