Currency substitution and the real exchange rate: the utility maximization approach

This paper studies the currency-substitution hypothesis with Rational Expectations in terms of a Sidrauski-type model where domestic and foreign money enter the utility function. It shows that, contrary to Liviatan (1981), the approach does not necessarily contradict Calvo and Rodriguez (1977). Furthermore, the impact of monetary stabilization policy is fully characterized with flexible and (pre-) fixed rates for an extension of Dornbusch and Mussa (1975). A brief analysis of the Optimal Quantity of Money is also provided.