Welfare Gains from Disinflation in an Economy With Currency Substitution

Welfare Gains from Disinflation in an Economy With Currency Substitution

Title : Welfare Gains from Disinflation in an Economy With Currency Substitution
Number : 10/09
Author(s) : H. Murat Özbilgin
Language : English
Date : May 2010
Abstract : This paper studies welfare gains from disinflation in the presence of currency substitution. A distinctive small open economy model with currency substitution and intermediated working capital is constructed for this objective. It is found that welfare gains from disinflation are higher when the baseline elasticity of substitution between foreign currency and domestic deposits is higher. Indeed the gains from disinflation can be quite large compared to previous studies especially for moderate rates of inflation if the two assets are highly substitutable under the baseline scenario. After the benchmark economy is specified, the model is used to assess welfare gains from disinflation for a given level of financial development. The model implies that, higher currency substitution is welfare enhancing for high inflation rates but not for moderate and low inflation rates. In other words, currency substitution is not necessarily welfare enhancing.
Keywords : Inflation, welfare, currency substitution, monetary policy
JEL Codes : E31, E51, F31, F41

Welfare Gains from Disinflation in an Economy With Currency Substitution
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