International Finance Discussion Papers (IFDP)
May 1995
Hysteresis in a Simple Model of Currency Substitution
Martin Uribe
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.
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