The relationship between currency competition and inflation

This paper draws upon Adam Smith's principle that individuals left to pursue their own self-interest will inherently promote the economic well-being of society Currency issuers want to gain seigniorage revenue by having the largest market share of people holding their currency Likewise, people want to hold the currency that has the most value. If a currency issuer is faced with less competition (domestic as well as international), it will be freer to use its monopolistic power and the result will be detrimental to society. This paper empirically investigates whether currency competition leads to lower inflation rates. Results show that a country's average inflation rate is higher after creating a monopolistic central bank. Also, a country's inflation rate is found to be negatively correlated with its 'Index of Freedom to Use Alternative Currencies' score. In particular, countries allowing citizens to legally hold foreign currency tend to have lower average rates of inflation. Generally, the results show that currency competition among issuers, either from abroad or within the country's boarders, enhances the incentives for monetary issuers to pursue lower inflation rates and produce a more credible money supply.