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Hyperinflation with Currency Substitution: Introducing an Indexed Currency

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  • Federico Sturzenegger

Abstract

Currency substitution (CS) and financial adaptation are in general 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 I show reduces the inflation rates along the hyperinflationary equilibrium. The intuition is simple: if agents have an easy way of substituting away from domestic currency then the required inflation rates to sustain a path where real balances disappears is necessarily lower. The implications of the model are then tested empirically.

Suggested Citation

  • Federico Sturzenegger, 1992. "Hyperinflation with Currency Substitution: Introducing an Indexed Currency," NBER Working Papers 4184, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:4184
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    References listed on IDEAS

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    1. Dornbusch, Rudiger & Reynoso, Alejandro, 1989. "Financial Factors in Economic Development," American Economic Review, American Economic Association, vol. 79(2), pages 204-209, May.
    2. Feenstra, Robert C., 1986. "Functional equivalence between liquidity costs and the utility of money," Journal of Monetary Economics, Elsevier, vol. 17(2), pages 271-291, March.
    3. José De Gregorio, 1991. "Welfare Costs of Inflation, Seigniorage, and Financial Innovation," IMF Staff Papers, Palgrave Macmillan, vol. 38(4), pages 675-704, December.
    4. Liviatan, Nissan, 1981. "Monetary Expansion and Real Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, vol. 89(6), pages 1218-1227, December.
    5. Engle, Robert & Granger, Clive, 2015. "Co-integration and error correction: Representation, estimation, and testing," Applied Econometrics, Publishing House "SINERGIA PRESS", vol. 39(3), pages 106-135.
    6. Flood, Robert P & Garber, Peter M, 1980. "Market Fundamentals versus Price-Level Bubbles: The First Tests," Journal of Political Economy, University of Chicago Press, vol. 88(4), pages 745-770, August.
    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.
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    Cited by:

    1. Alexandre Sokic, 2012. "The Monetary Analysis of Hyperinflation and the Appropriate Specification of the Demand for Money," German Economic Review, Verein für Socialpolitik, vol. 13(2), pages 142-160, May.
    2. Gustavo Suárez R., 1999. "Tecnología de transacciones endógena y los costos de la inflación," Ensayos sobre Política Económica, Banco de la Republica de Colombia, vol. 0(35), pages 55-85, Junio.
    3. William C. Gruben & Darryl McLeod, 2004. "Currency competition and inflation convergence," Center for Latin America Working Papers 0204, Federal Reserve Bank of Dallas.
    4. Vazquez, Jesus, 1998. "How high can inflation get during hyperinflation? A transaction cost demand for money approach," European Journal of Political Economy, Elsevier, vol. 14(3), pages 433-451, August.
    5. Von dem Berge, Lukas, 2014. "Parallel currencies in historical perspective," CAWM Discussion Papers 75, University of Münster, Center of Applied Economic Research Münster (CAWM).
    6. Kem Reat Viseth, 2001. "Currency Substitution and Financial Sector Developments in Cambodia," International and Development Economics Working Papers idec01-4, International and Development Economics.

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