Inflationary finance, capital controls, and currency substitution

Research output: Journal Publications and Reviews (RGC: 21, 22, 62)21_Publication in refereed journal

3 Scopus Citations
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Author(s)

Detail(s)

Original languageEnglish
Pages (from-to)597-612
Journal / PublicationReview of International Economics
Volume7
Issue number4
Publication statusPublished - Nov 1999
Externally publishedYes

Abstract

This paper studies currency substitution in an environment where agents' inflation tax-evasive demand for foreign money is balanced by the concern for the possibility that the government may impose economy-wide capital controls under which foreign currency transactions are costly. Under the assumption of endogenous beliefs, the results show a persistent demand for foreign money despite efforts by the government to reduce inflation. In addition, the economy can exhibit multiple, Pareto-ranked steady states with different levels of currency substitution. The stability analysis suggests that the economy converges to the inferior steady state, on the 'wrong side' of the Laffer curve.