Money Demand and Inflation in a Highly Dollarized Economy: Fighting Inflation in Cambodia

Money supply in a highly dollarized Cambodian economy appears to be highly unstable because the composition of domestic currency in aggregate money supply is very small. During its transition towards a market economy, Cambodia embarked upon a path of disinflation through dollarization and stable exchange rate. In this paper, the trend and behavior of money supply, money demand and inflation are examined, and a model is developed to explain the determinants of inflation under dollarization and estimate it for Cambodia in the 2000s using a two-step procedure. This paper also shows that management of rice price, gasoline price with a restrictive monetary policy based on broadly defined money or total liquidity was essential for the Cambodian authorities to succeed in fighting inflation. This paper explain the behavior of inflation and the role that a central bank may play in its determination