Currency substitution or “dollarization” is often viewed as an inflationary source of exchange rate volatility. But in fact the consequences of “partial dollarization” depend on how Central Banks respond to competition. If seigniorage financed fiscal deficits are fixed, dollarization can lead to exchange rate fluctuations and higher inflation if not new capital controls, as much of the currency substitution literature suggests. However, if Central Banks respond by lowering money growth to maximize seigniorage revenues, inflation falls. This paper presents a simple model of currency competition and with open capital markets and optimizing central banks to illustrate this point. Empirical tests for Latin America and twenty other countries suggest that dollarization is both a legacy of past inflation and a constraint on future inflation. Dollarization may complicate monetary policy and prudential regulation, but currency competition also appears to accelerate disinflation and contribute to inflation convergence, particularly in Latin America.

The growing divergence between national accounts and survey-based estimates of developing country consumption per capita is fueling a controversy over how much poverty fell during the 1990s. This paper ranks rival per capita growth rates with respect to their ability to predict changes in a range of non-monetary welfare indicators including nutritional status, child mortality, school enrollment rates, etc. National accounts based growth estimates, particularly those of the Penn World Tables, generally out-perform survey based growth rates in these tests.