Parallel currencies under free floating exchange rates: A model setting out the conditions for stable currency competition

We use a theoretical model to set up the conditions for a country to attain monetary stability by allowing for two freely tradable currencies to circulate in parallel. For this parallel system to function properly, confidence in the good behavior of the monetary authorities in charge of the two currencies is key. Our model shows how a floating exchange rate between the two can keep the issuers of the local currency in check. The results from our model show the conditions under which a parallel currency system disciplines the issuers of the currencies and thus maintains their purchasing power. In non-volatile economies, it also discourages governments (or private issuers) from inflating one of the currencies as a means to raise seigniorage, as this policy results in the displacement of the currency from the market. When foreign payments shortfall - such as in Greece and Cyprus during the 'euro crisis' in the mid-2010s, or intractable hyperinflation - leave the country without a medium of exchange, our model shows how currency choice can restore monetary circulation and offer a path to achieving and maintaining monetary stability.