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Inflationary Finance, Capital Controls, and Currency Substitution
Author(s) -
Tandon Ajay,
Wang Yong
Publication year - 1999
Publication title -
review of international economics
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.513
H-Index - 58
eISSN - 1467-9396
pISSN - 0965-7576
DOI - 10.1111/1467-9396.00185
Subject(s) - currency substitution , economics , laffer curve , inflation tax , inflation (cosmology) , monetary economics , currency , capital (architecture) , macroeconomics , monetary policy , devaluation , tax reform , market economy , state income tax , physics , archaeology , theoretical physics , gross income , history
This paper studies currency substitution in an environment where agents’ inflation tax‐evasive demand for foreign money is balanced by the concern for the possibility that the government may impose economy‐wide capital controls under which foreign currency transactions are costly. Under the assumption of endogenous beliefs, the results show a persistent demand for foreign money despite efforts by the government to reduce inflation. In addition, the economy can exhibit multiple, Pareto‐ranked steady states with different levels of currency substitution. The stability analysis suggests that the economy converges to the inferior steady state, on the “wrong side” of the Laffer curve.