International Finance Discussion Papers (IFDP)
July 1985
Currency Substitution and the New Divisia Monetary Aggregates: The U.S. Case
Jaime Marquez
Abstract:
The purpose of this paper is to examine the extent to which the behavior of aggregate money holdings is influenced by foreign exchange considerations, an influence that has been labeled as currency substitution. Knowledge of the extent to which monies of different countries can substitute for each other is important for the design and implementation of monetary policy. However, existing empirical analyses of currency substitutions rest on official estimates of money holdings which imply an infinite elasticity of substitution between different monetary assets. Analyses of economic monetary aggregates do not impose the assumption of infinite elasticity of substitution, but no foreign exchange considerations are allowed. This paper combines both approaches into a unified explanation of money demand behavior.
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