HYSTERESIS IN A SIMPLE-MODEL OF CURRENCY SUBSTITUTION

A cash-in-advance model in which the cost of buying goods with a forei gn currency is decreasing in the economy's accumulated experience in t ransacting in the foreign currency is shown to display hysteresis in m oney velocity; that is, a temporary increase in expected inflation can cause a permanent increase in velocity. In addition, the model implie s that the domestic currency does not have to dominate the foreign cur rency in rate of return to induce agents to stop using the foreign cur rency. Finally, inflation rates that trigger currency substitution nee d not be associated with steady states in which the domestic currency disappears from circulation.