Currency Substitution


DEFINITION of 'Currency Substitution'

The use of a foreign currency in transactions in place of the domestic currency. The foreign currency thus serves as a medium of exchange. Countries using flexible exchange rates can experience problems if there is a high rate of currency substitution because they can no longer control all currency types through monetary policy. The higher the rate of currency substitution, the greater the likelihood of monetary disturbances caused by changes in the foreign currency.

BREAKING DOWN 'Currency Substitution'

A country may choose to use flexible exchange rates rather than fixed exchange rates in order to mitigate the effect of foreign currency fluctuations on the domestic currency and economy. An increase in the rate of currency substitution means that the domestic economy can fall victim to rapid changes in exchange rates, and thus may experience monetary increased shocks from both home and abroad.

  1. Monetary Policy

    Monetary policy is the actions of a central bank, currency board ...
  2. Exchange Rate

    The price of a nation’s currency in terms of another currency. ...
  3. Dollarization

    A situation where the citizens of a country officially or unofficially ...
  4. Foreign Currency Swap

    An agreement to make a currency exchange between two foreign ...
  5. Linked Exchange Rate System

    A system of managing a nation's currency and exchange rate by ...
  6. Pegging

    1. A method of stabilizing a country's currency by fixing its ...
Related Articles
  1. Forex Education

    Currency Exchange: Floating Rate Vs. Fixed Rate

    Baffled by exchange rates? Wonder why some currencies fluctuate while others are pegged? This article has the answers.
  2. Personal Finance

    How The U.S. Government Formulates Monetary Policy

    Learn about the tools the Fed uses to influence interest rates and general economic conditions.
  3. Forex Education

    Dual And Multiple Exchange Rates 101

    Why would a country choose to implement dual or multiple exchange rates? It's risky, but it can work.
  4. Personal Finance

    What Are Central Banks?

    They print money, they control inflation, and much, much more. All you need to know about central banks is here.
  5. Investing

    5 Companies Benefiting From Germany's Record Surplus

    A weaker euro is boosting German exports, which have led to a record trade surplus. Here are five German companies reaping the benefits.
  6. Economics

    Ukraine-Russian Sanctions: The Gift That Keeps On Giving

    The repercussions of Russia's 2014 invasion of Crimea are nowhere near over. The Ukraine says Russian aircraft are no longer welcome to take off or land in Ukraine's airports.
  7. Stock Analysis

    Top 5 Companies Owned by Ford

    Discover some of Ford Motor Company's most important subsidiaries and joint ventures, and learn more about what they do to further Ford's business interests.
  8. Investing

    Which Economy Is Larger - The United States or China?

    China's economy may be larger than the U.S. economy, but it all depends on which exchange rate method you use to make the GDP comparisons.
  9. Investing

    What a U.S. - Asia Trade Deal Means For Business

    The U.S. and 11 other countries, comprising 40% of the world’s total economic output, have finally reached agreement on the Trans-Pacific Partnership.
  10. Mutual Funds & ETFs

    Top 3 Emerging Markets Bond Mutual Funds

    Discover detailed analysis of the top three mutual funds offering exposure to the emerging markets bonds, and learn about the suitability of these funds.
  1. What are the goals of covered interest arbitrage?

    The goals of covered interest arbitrage include enabling investors to trade volatile currency pairs without risk as well ... Read Full Answer >>
  2. What kinds of costs are included in Free on Board (FOB) shipping?

    Free on board (FOB) shipping is a trade term published by the International Chamber of Commerce or ICC, that indicates which ... Read Full Answer >>
  3. What are the differences between B-shares and H-shares traded on Chinese stock exchanges?

    Equity listings in China generally fall under three primary categories: A shares, B shares and H shares. B shares represent ... Read Full Answer >>
  4. What are the differences between H-shares and A-shares on Chinese and Hong Kong stock ...

    Publicly trade companies in China generally fall under three share categories: A shares, B shares and H-shares. A-shares ... Read Full Answer >>
  5. Why are financial markets considered to be transparent?

    Financial markets are considered transparent due to the fact it is believed all relevant information is freely available ... Read Full Answer >>
  6. How does a Foreign Institutional Investor (FII) manage currency risk when investing ...

    A foreign institutional investor (FII) manages currency risks (inflation and exchange rate risk) by using traditional tools ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Ex Works (EXW)

    An international trade term requiring the seller to make goods ready for pickup at his or her own place of business. All ...
  2. Letter of Intent - LOI

    A document outlining the terms of an agreement before it is finalized. LOIs are usually not legally binding in their entirety. ...
  3. Purchasing Power

    The value of a currency expressed in terms of the amount of goods or services that one unit of money can buy. Purchasing ...
  4. Real Estate Investment Trust - REIT

    A REIT is a type of security that invests in real estate through property or mortgages and often trades on major exchanges ...
  5. Section 1231 Property

    A tax term relating to depreciable business property that has been held for over a year. Section 1231 property includes buildings, ...
  6. Term Deposit

    A deposit held at a financial institution that has a fixed term, and guarantees return of principal.
Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!