INTERNATIONAL CURRENCY SUBSTITUTION AND SEIGNIORAGE IN A SIMPLE-MODELOF MONEY

This paper investigates the economic significance of currency substitu tion using a small, open economy model of money. The main result is th at in a low-inflation economy the seigniorage-maximizing inflation rat e can be quite large despite a very high elasticity of currency substi tution when the share of foreign veal balances in producing domestic l iquidity services is small (as some recent econometric estimates indic ate in the case of Canada). This suggests that currency substitution i s likely to be of second-order importance to policymakers in a low-inf lation economy where foreign real balances provide economically small domestic liquidity services.