Hysteresis in a Simple Model of Currency Substitution
Abstract
A simple model of currency substitution is developed in which the private cost of performing transactions in the foreign currency depends upon the aggregate degree of dollarization. This feature generates multiple steady states and hysteresis in an otherwise standard cash-in-advance model of a small open economy. In particular, a temporary increase in the rate of inflation can drive the economy to a dollarized equilibrium in which the velocity of circulation of domestic currency is permanently higher.
ABSTRACT A simple model of currency substitution is developed in which the private cost of performing transactions in the foreign currency depends upon the aggregate degree of dollarization. This feature generates multiple steady states and hysteresis in an otherwise standard cash-in-advance model ofa smallopen economy. In particular, a temporaryincrease in the rate ofinflation can drive the economy to a dollarized equilibrium in which the velocity of circulation of domestic currency is permanently higher.
Cite this document
Martin Uribe (1995). Hysteresis in a Simple Model of Currency Substitution (IFDP 1995-509). Board of Governors of the Federal Reserve System, International Finance Discussion Papers. https://whenthefedspeaks.com/doc/ifdp_1995-509
@techreport{wtfs_ifdp_1995_509,
author = {Martin Uribe},
title = {Hysteresis in a Simple Model of Currency Substitution},
type = {International Finance Discussion Papers},
number = {1995-509},
institution = {Board of Governors of the Federal Reserve System},
year = {1995},
url = {https://whenthefedspeaks.com/doc/ifdp_1995-509},
abstract = {A simple model of currency substitution is developed in which the private cost of performing transactions in the foreign currency depends upon the aggregate degree of dollarization. This feature generates multiple steady states and hysteresis in an otherwise standard cash-in-advance model of a small open economy. In particular, a temporary increase in the rate of inflation can drive the economy to a dollarized equilibrium in which the velocity of circulation of domestic currency is permanently higher.},
}