ABSTRACT
We extend the Thomas (1985) dynamic optimizing model of money demand currency substitution to the case in which the individual has restricted or no access foreign currency denominated bonds. In this case currency substitution decisions and a substitution decisions are not separable. The results obtained suggest that the significance of an expected exchange rate depreciation term in the demand for domestic money provides a valid test for the presence of currency substitution. Applying this approach to six Latin American countries, we find evidence of currency substitution in Colombia, Dominican Republic, and Venezuela, but not in Brazil and Chile.
