Currency Substitution and Inflation in Peru

IMF Working Papers, May 1, 1992

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There is a long-run relationship between the expected rate of depreciation in the black-market-exchange rate and the ratio of domestic to foreign money in Peru; that is, the hypothesis of currency substitution can explain the behavior of real holdings of money in Peru.
The paper shows that the importance of currency substitution as a transmission mechanism through which domestic policies affected the dynamics of inflation was relatively small during a period of high but relatively stable inflation (January 1978-85).
The paper shows that currency substitution became an important factor in the inflation process during the recent hyperinflation episode.

Empirical analysis linking expected rate of depreciation in the black-market-exchange rate to the ratio of domestic to foreign money.
Emphasis on currency substitution (dollarization) as an explanatory mechanism for real money holdings and as a transmission channel for domestic policy into inflation dynamics.

During January 1978-85: currency substitution played a relatively small role in transmitting domestic policies into inflation dynamics despite high but relatively stable inflation.
During the recent hyperinflation episode: currency substitution emerged as an important factor shaping the inflation process.

Subjects: Bank deposits, Dollarization, Exchange rates, Financial services, Foreign exchange, Government debt management, Inflation, Monetary policy, Prices, Public financial management (PFM)
Keywords: Bank deposits, currency substitution, Dollarization, domestic money, Exchange rates, foreign currency, foreign money, Government debt management, Inflation, inflation equation, inflation rate, money holder, transmission mechanism, U.S. dollar, WP

Liliana Rojas-Suárez; May 1, 1992. "Currency Substitution and Inflation in Peru."