Currency Substitution, U.S. Money Demand, and International Interdependence

Abstract

A number of writers have argued in recent years that massive international currency substitution has been a major cause of exchange rate volatility and monetary instability in the United States and other major countries. Such analysis is frequently coupled with recommendations for a return to pegged exchange rates. This paper critically examines the evidence presented for this currency substitution view. It argues that the weight of latest research suggests that direct international currency substitution has not been of major quantitative importance for the U.S. However, empirical evidence supports traditional views that international capital mobility can generate substantial short‐run monetary interdependence even under flexible exchange rates. Thus, even though international currency substitution is of little importance to U.S. monetary conditions, a broader range of international considerations may be of considerable importance for the U.S. economy.

Key Exchange Rate Regimes: A Constitutional Perspective

“…"While some initial empirical research did support McKinnon's view on the importance of international currency substitution for the United 5tates, these findings did not hold up strongly in light ofsubsequent research. For recent critical surveys ofthis empirical literature, see Willett et al (1987). "See Mayer and Willett (1988).…”