Inflation,interest rate policy,and currency substitutions in developing economies: A discussion of some major issues

This paper deals with the management of interest rates in an open economy under rapid inflation and reviews the links between interest and exchange rate policies.To prevent current substitution the rate of interest paid to lenders must equal the equivalent rate after adjusting for differential taxation and intermediation costs. This would probably induce capital inflows and consequent monetary growth. Exchange risks are also considered in this context.The paper concludes that under inflationary conditions it is difficult to use only interest rates to achieve both proper resource allocation and prevention of currency substitution. Some policy measures to cope with this problem are discussed.