The Real Effects of Foreign Inflation in the Presence of Currency Substitution

29 Pages Posted: 15 Mar 2007 Last revised: 7 Nov 2022

See all articles by Charles M. Engel

Charles M. Engel

University of Wisconsin - Madison - Department of Economics; National Bureau of Economic Research (NBER); University of Washington - Department of Economics

Date Written: February 1987

Abstract

The paper explores optimizing models of small open economies that hold foreign money balances. Particular attention is paid to the impact of foreign inflation on the real exchange rate and other real variables. At first, an environment in which foreign money is the only traded asset is explored. This is compared to a more general setting in which many assets can be traded. The effect of foreign inflation on domestic real variables depends on: 1) the degree to which it causes a substitution out of traded assets as a whole and into non-traded assets, and 2) the change in real returns on the portfolio of traded assets held by domestic residents.

Suggested Citation

Engel, Charles M., The Real Effects of Foreign Inflation in the Presence of Currency Substitution (February 1987). NBER Working Paper No. w2140, Available at SSRN: https://ssrn.com/abstract=971619

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