Currency Substitution in Developing Countries: An Introduction

IMF Working Papers, May 1, 1992

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This paper reviews the main policy and analytical issues related to currency substitution in developing countries.
The paper discusses:
- whether currency substitution should be encouraged or not;
- how the presence of currency substitution affects the choice of nominal anchors in inflation stabilization programs;
- the effects of changes in the rate of growth of the money supply on the real exchange rate;
- the interaction between inflationary finance and currency substitution;
- issues related to the empirical verification of the currency substitution hypothesis.

Currency substitution: examination of policy rationale for encouraging or discouraging currency substitution in developing countries.
Nominal anchors and stabilization: analysis of how currency substitution modifies the choice and effectiveness of nominal anchors in inflation stabilization programs.
Money supply growth and real exchange rate: exploration of the effects of changes in the rate of growth of the money supply on the real exchange rate.
Inflationary finance interaction: discussion of the interaction between inflationary finance and currency substitution.
Empirical verification: issues related to testing the currency substitution (substitution) hypothesis empirically.

Subject: Currencies, Demand for money, Dollarization, Foreign exchange, Inflation, Monetary policy, Money, Prices, Real exchange rates
Keywords: Currencies, currency substitutability, currency substitution, currency-substitution problem, Demand for money, Dollarization, dollarization process, domestic money, foreign currency, Inflation, inflation rate, medium of exchange, nominal interest rate, Real exchange rates, substitution hypothesis, WP