October 1985

Money Demand in Open Economies: A Currency Substitution Model for Venezuela

Jaime Marquez


This paper investigates the extent to which domestic money balances in Venezuela are influenced by foreign exchange considerations. To this end, individuals are assumed to choose the levels of foreign and domestic money that minimize the borrowing costs associated with a given level of monetary services. The solution to this optimization problem yields a closed form domestic money demand function. This specification is estimated and the results point to an elasticity of currency substitution in excess of one. Conditioned on these estimates, the paper presents estimates of the out-of-sample exchange-rate risk for the period 1981-1982, prior to the collapse of the fixed exchange rate system in 1983.

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Last Update: August 13, 2021