The Benefits of Currency Substitution during High Inflation and Stabilization

Abstract

Allowing currency substitution in a very high inflation helps to maintain the level of output, as the distortion of the information carried by prices is mitigated. The total (primary plus secondary) money supply may increase if currency substitution is permitted. Currency substitution does not even necessarily reduce the real primary money stock. Moreover, the demand for the primary money fragments at very high rates of inflation, which means that the authorities may lose little when they give up the attempt to obtain inflation tax revenue. Currency substitution need be no more expensive, in terms of the real resources it consumes, than is indexation. Finally, the availability of a second stable currency may reduce the severity of post-stabilization recessions.