Hyperinflation with Currency Substitution: Introducing an Indexed Currency
Currency substitution (CS) or indexed currencies are believed to increase the equilibrium rate of inflation. This result derives from a setup in which the government finances a certain amount of real resources through money printing and where CS reduces the base of the inflation tax. This paper shows this intuition wrong for those situations where the hyperinflation is expectations-driven. Incorporating CS in an Obstfeld-Rogoff (1983) framework, we show, reduces the inflation rates along the hyperinflationary equilibrium. The intuition is simple: if money losses 'essentiality' - because a very close substitute develops or becomes available - then the inflation rates which induce agents to reduce their monetary balances fall. The implications of the model are then tested empirically. Copyright 1994 by Ohio State University Press.
Volume (Year): 26 (1994)
Issue (Month): 3 (August)
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