Abstract:

The currency substitution, which is a universal phenomenon in condition of opening to the world, affects exchange rate in both static and dynamic sides. If a general price level is flexible, the currency substitution will make a magnification effect on exchange rate; while the price level is stick, it will make a tardy effect on exchange rate. The developing countries including China must make anti-substitution policies such as reducing internal inflation rate, opening to thd world properly, narrowing the gap between internal and external interest rates. Therefore, it is very important and necessary for those countries to build an exchange rate target zone system in order to avoid currency substitution and financial risks.

Key words: currency substitution, exchange rate effect, exchange rate target zone