Currency transactions costs and competing fiat currencies

This paper develops a model in which two competing fiat currencies may coexist as media of exchange. Domestic currency has lower transactions costs but a higher growth rate than foreign currency, it is used in everyday transactions and has a higher velocity of circulation in equilibrium. In contrast, foreign currency is hoarded for occasional high consumption shocks. A precautionary transactions demand for foreign currency arises because it is a better store of value. The different endogenous roles for the currencies provide an explanation for the nondisappearance of the hyperinflating domestic currency in the presence of a stable foreign currency. Though the presence of foreign currency lowers the value of the domestic currency, it may increase welfare when large amounts of seigniorage must be generated. (C) 2000 Elsevier Science B.V. All rights reserved.