Dollarization and the conquest of hyperinflation in divided societies

Cooper, Russell W.; Kempf, Hubert

Journal Article

Dollarization and the conquest of hyperinflation in divided societies

Abstract: This study argues that the delegation of monetary policy control by one country to another can reduce inflation in the delegating country. Hyperinflation is common in a divided society, one in which special interest groups can pressure a weak central government to issue money to finance their own demands while neglecting the country?s overall welfare. A commitment device like dollarization or a currency board, which gives control of the divided country?s money supply to another country, can eliminate this inflation bias. This is illustrated by Argentina?s experience with inflation and a currency board which, in effect, gave control of Argentina?s money supply to the United States. This argument is made precise using a two-country overlapping generations model to study the effects of delegation. The study also finds that a dollarization treaty between the two countries can be welfare-improving for both

Keywords: Dollarization;