Complementary Currencies and Liquidity : The Case of Coca-Base Money

In coca-growing villages of Colombia, where pesos are scarce, coca-base is not only used as the main input for cocaine production—it also acts as a complementary currency (CC), circulating locally as a medium of exchange for day-to-day transactions. This paper provides a clear rationale for the economically-motivated adoption of a CC in a small open economy underprovided with official currency. An equilibrium currency shortage arises endogenously in our model, whereby shocks to the local supply of currency have a real impact on local trade and welfare. We show how a CC can mitigate the underprovision of liquidity and derive general insights relating the CC’s characteristics to its ability to supplement the official currency. In an application, we quantify the unintended consequences of various anti-narcotic policies pursued by the Colombian government on liquidity provision in coca-growing villages and identify the least-harmful policy tools given the policy objectives at stake