Each factor affects the cost-benefit tradeoff of pursuing a highinflation policy. The first factor, which gets surprisingly little attention in my view, is financial innovation that alters the ability and incentive of a government to pursue a high-inflation policy. 7 I put the innovations into two main categories, developments in information technology and physical dollarization, both of which effectively increase potential competition among currencies.
Financial innovations make it easier for citizens to move their assets out of the local currency should their government resort to an inflation tax. The dollarizations that followed the high-inflation episodes in Latin America and the former Soviet Union, for example, significantly reduced the costs of switching away from a local currency for smallvalue transactions.