Degree Of Currency Substitution Research Articles

CURRENCY SUBSTITUTION AND THE DEMAND FOR MONEY IN FIVE EUROPEAN UNION COUNTRIES

The high degree of economic integration has led to an increased degree of currency substitution in the EU countries, which could bring instability in national money demand functions while an EU-wide money demand function could be more stable. Currency substitution usually takes the form of cross border deposits (CBD), which are not included in the traditional monetary aggregates. Thus, extended monetary aggregates that include the relevant CBDs are defined in this study. In order to investigate the implications of currency substitution for the stability of the demand functions, the traditional and extended monetary aggregates for five EU countries are defined in addition to EU-wide monetary aggregates. The estimated EU-wide demand for extended money appears to be stable suggesting that there is scope for monetary policy at the European level. However, the stability of the area-wide aggregate has been impaired when the relevant CBDs are not included.

Investigating the Time: The Varying Nature of The Link Between Inflation And Currency Substitution inThe Turkish Economy

This study investigates the relationship between the rate of inflation and the degree of the currency substitution for Turkey during 1986-2006. Our results show that the correlation coefficient between the two variables has not been constant over time. The results of the Multivariate GARCH model estimated to obtain the correlation coefficients indicate that there is a nonlinear relationship between the inflation rate and the degree of currency substitution. The main policy implication of our study is that it is difficult to stop or to reverse the currency substitution unless a confidence in the domestic currency is established.

Currency Substitution and Financial Repression

In this paper, we use a general equilibrium overlapping generations monetary endogenous growth model of a small open economy, to analyze whether financial repression, measured via the ‘high’ mandatory reserve-deposit requirements of financial intermediaries, is an optimal response of a consolidated government following an increase in the degree of currency substitution. We find that higher currency substitution can yield higher reserve requirements, but the result depends crucially on how the consumer weighs money in the utility function relative to domestic and foreign consumptions, and also the size of the government.

Currency Substitution and Network Externalities

It is a known fact that the use of foreign currency by domestic residents shows significance persistence, even hysteresis. Temporary changes in the inflation rate can have permanent effects on the degree of currency substitution, as illustrated by the case of Bolivia, where dollarization has remained at a particularly high level after stabilization. The paper presents a simple model of currency substitution with network effects among agents with heterogeneous transaction costs. A network of foreign currency users reduces transactions costs for all prospective users of this currency. The strength of the network effects increases with size, which is defined as the number of agents whose foreign currency balances are larger than a given threshold. The network's size is endogenously determined. Its dynamics and the possibility of multiple equilibria generate patterns of currency substitution which exhibit persistence and hysteresis.

Confidence in Domestic Money and Currency Substitution

This article studies currency substitution in a model where domestic money suffers from lack of confidence. When agents' confidence is exogenous and constant, there is a unique but unstable dual‐money steady state. However, when agents' confidence is updated endogenously, the dynamics of currency substitution are driven by agents' evolving beliefs, and the economy always converges to an equilibrium where both monies circulate. Therefore, the economy under endogenous beliefs exhibits both persistence in currency substitution and tenacity of domestic money. Furthermore, in general, there are multiple steady states, which can be Pareto ranked by the degree of currency substitution.

Econometric Analysis of Currency Substitution: A Case of Latvia

The paper provides a comprehensive econometric analysis of currency substitution for Latvia. Rather than drawing inferences on the degree of currency substitution from domestic money demand modelling, the most common approach to empirical analysis of the phenomenon, direct modelling of currency substitution ratio is applied. Extensive model construction, estimation, evaluation and testing are performed. Methodological issues are also discussed. No simple policy recommendations can be made at this stage of research, but a number of instruments are identified, which can be used by the authorities to influence currency substitution behaviour.

Testing the currency-substitution model under the German hyperinflation

In this paper the currency-substitution model is tested under the German hyperinflation using several expectations-formation mechanisms. The maximum-likelihood estimates of the currency-substitution model reveal that extrapolative and adaptive expectations seem to have been predominant and that there was a significant degree of currency substitution. The results also reveal that expectation was destabilizing and that it was not possible to distinguish between the effects of the expected change in the exchange rate and the expected inflation.

Currency substitution and exchange rate instability: The Turkish case

In this paper we present evidence for the extent of currency substitution and its effects on exchange rate instability in Turkey. Following the capital account liberalization in 1987, the private sector has responded to the failed stabilization efforts of successive Governments by requesting higher real interest rates on Government debt and by increasing its holdings of foreign exchange at the expense of domestic currency. Theoretical models of exchange rate determination indicate that exchange rate instability increases with the degree of currency substitution. We use an exponential GARCH (E-GARCH) model for exchange rate depreciation and find evidence in support of this hypothesis. Furthermore we test for the extent of currency substitution in determining short-run dynamics of real money balances utilizing the expected depreciation series obtained from the E-GARCH model.

Is there a ?triffin dilemma? for the EMS?

The question explored in this paper is whether the EMS can continue to perform efficiently and ensure low inflation in an economically and financially integrated area with a high degree of currency substitution. A dilemma may arise: on the one hand, currency substitution should be accommodated to provide market participants with the currency they desire; on the other, currency substitution should not determine an excess of liquidity in the system leading to inflation. These objectives might be difficult to reconcile in a system with decentralized asymmetric monetary policy cooperation such as the EMS and might have adverse consequences for the monetary stability of the system.

Currency Substitution: The Recent Experience of Bolivia

This paper analyzes the determinants of currency substitution in Bolivia in the period following the 1984/85 hyperinflation. We find that expected exchange rate depreciation and actual interest rate differentials between boliviano and dollar deposits in the Bolivian banking system are statistically significant determinants of the degree of currency substitution. However, the explanatory power of these variables is low compared to variables that measure the degree of inertia in the currency substitution process. Thus, further reductions in inflation or higher interest rates for boliviano bank deposits are likely to have but a small effect on dollarization.

Currency substitution and exchange rate dynamics: A note

In an interesting paper Girton and Roper [ 1981 ] examine the effects of currency substitution on exchange rate variability. They find that currency substitution increases exchange rate volatility and that the exchange rate is indeterminate when currency substitution approaches infinity. It is only by endogenizing the behavior of money issuers in the second part of Girton and Roper' s paper and by assuming that central banks behave as profit maximizers that they are able to show that currency substitution enhances exchange rate stability. The main reason for the latter result is that central banks are assumed to respond to demand shifts for their currencies in an attempt to maximize profits. The first part of the Girton and Roper paper, dealing with exogenous money supplies, relies heavily on two assumptions. Namely, the assumption that purchasing power parity (PPP) holds at every instant in time and the assumption of perfectly flexible commodity prices. Thus changes in relative money supplies affect relative national price levels immediately, and given PPP, cause proportional changes in the exchange rate. By contrast, expected depreciation of one of the two currencies decreases the differential between its anticipated real return and that of the other currency. This in turn causes a decrease in its demand and a symmetrical increase in the demand for the other currency. Moreover, the demand for the first currency further decreases as its anticipated real return falls in relation to the non-monetary asset. In the latter case, the degree of change in the relative national price levels and hence exchange rate change depends on the degree of currency substitution. If the two currencies are close substitutes, the resulting shifts in their de-

Imperfect asset substitution in a two-country model

The paper reports results obtained from the simulation of a two-country model in which the real and financial sectors are integrated under an assumption of rational expectations and steady state inflationary equilibria. The government of each country issues a single financial asset (‘currency’) which is held by the government of the other country and by the private residents of both countries. The model is simulated under a variety of shocks and the effects of higher currency substitution (measured in different ways) are explored. The results show that, depending on the shock hitting the system and the way in which the degree of currency substitution is measured, higher levels of currency substitution may reduce instead of increasing the degree of exchange rate overshooting and may even convert overshooting into undershooting. The paper lays a basis for various extensions which will be reported in subsequent papers.

Exchange rate volatility and currency substitution

This paper employs a conventional small open economy portfolio balance macromodel to unveil new implications of currency substitution. Increased substitutability between foreign and domestic currency is found to affect the response of the exchange rate of both asset market and commodity market shocks. In particular, the extent of exchange rate overshooting and undershooting depends on the degree of currency substitution.

Substitution Among Currencies: A Preferred Habitat Hypothesis

This paper embeds the theory of currency substitution in the theory of the transactions demand for money. It agrues that the domestic currency, as the most convenient and preferred domestic medium of payments, is the preferred habitat for transactions balances. With foreign currencies acting only as liquid stores of value, the degree of currency substitution is further reduced by the presence of short-time bonds under a yield dominance hypothesis. The empirical evidence on Canadian money demand functions supports our analytical findings: the degree of substitution between the Canadian and U.S. currencies for Canadian residents is virtually non-existent. [430]

Currency Substitution and Western European Monetary Unification

The recent history of European monetary affairs may be interpreted as slow movement towards the establishment of European currency union characterized by fixed exchange rates and perhaps, eventually, common European currency. Until very recently, the desirability of European monetary union was analysed in terms of the traditional optimum currency area framework.' In that analysis, the incentive for currency union comes from the potential improvements in efficiency in resource allocation from the use of single money in trade area. Recently, however, the question of the independence of monetary policy under flexible exchange rates has spawned growing literature on currency substitution which includes implications for currency 2 union. The earlier work suggested that major benefit of flexible rates would be the liberation of domestic monetary policy from external balance concerns, so that policy could be aimed singularly at internal balance.3 The currency substitution (CS) literature has demonstrated that, if the currencies of two countries are close substitutes to money-demanders, then the central banks of these countries cannot follow independent monetary policies even under flexible exchange rates.4 The degree of currency substitution is an important empirical question, and the analysis that follows should prove informative in determining the incentive for European monetary union. Is the European Monetary System (EMS) goal of reducing exchange rate fluctuations necessarily indicative of European sensitivity to disturbances with a substantial part of the problem coming from substitution between monies (Girton and Roper, 1980, p. 157), or rather result of the traditional drive towards integration as envisioned by optimum currency area theory? The following sections will suggest an answer.

Currency Substitution and the Demand for Money: Some Evidence for Canada

RECENTLY, THE POSSIBILITY THAT foreign and domestic currencies are substitutes has received considerable attention (see [1, 2, 3, 10, 19, 21]). Currency substitution has important implications for the working of flexible exchange rates. If the degree of currency substitution is high, small changes in the money supply would induce large changes in the exchange rate. Furthermore, currency substitution would transmit the effect of monetary disturbances from one country to another. Indeed, significant currency substitution would seriously undermine the ability of flexible exchange rates to provide monetary independence. This paper examines the empirical importance of currency substitution in the framework of the demand function for money. If currency substitution is important, the expected change in the exchange rate should be a significant determinant of the demand for home currency. In section 2, we undertake such a test for the Canadian demand for money during the recent flexible exchange rate period. There is considerable evidence that the forward exchange rate is a good measure of the expected exchange rate. Our own tests confirm these results for Canadian data since 1970.