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The Dynamics of Inflation and Currency Substitution in a Small Open Economy

Miguel de Freitas ()

No 1/2004, NIPE Working Papers from NIPE - Universidade do Minho

Abstract: In this paper, we analyse the relationship between money and inflation in a small open economy where domestic and foreign currencies are perfect substitutes as means of payment. It is shown that, if the path of domestic money supply is such that individuals find it optimal to change the currency in which transactions are settled, there will be an adjustment period during which domestic inflation adjusts so as to equalise the foreign inflation rate. In the case of a disinflation program, it is shown that the foreign currency is not necessarily abandoned as means of payment. The results obtained are consistent with both dollarisation hysteresis and reversibility, without requiring the specification of dollarisation costs.

Keywords: currency substitution; dollarisation; money-demand and hysteresis. (search for similar items in EconPapers)
JEL-codes: E41 E52 F41 (search for similar items in EconPapers)
Date: 2004
New Economics Papers: this item is included in nep-ifn, nep-mac and nep-mon
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Journal Article: The dynamics of inflation and currency substitution in a small open economy (2004) Downloads
Working Paper: The dynamics of inflation and currency substitution in a small open economy (2003) Downloads
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