Currency/asset substitution in developing countries: The Turkish case.

摘要

In the process of an inflation rate increase, there is commonly a shift away from the use of domestic money toward the use of foreign money. The reason for this shift is that foreign money provides more appropriate services in terms of performing the functions of money, which are store of value, unit of account, and medium of exchange. The loss of purchasing power of domestic currency increases the demand for foreign currency.; This study explores the determinants of currency substitution of the Turkish economy in the last two decades. Most of the empirical studies on currency substitution have focused on high inflation South American countries. This study extends the previous analysis of currency substitution to Turkey, an emerging market with prolonged high to moderate inflation.; In particular, the study analyzes the following set of interrelated questions: What is the degree of currency substitution in Turkey? What are the determinants that have driven the currency substitution process in the Turkish economy? Is there an asymmetric substitution process between domestic and foreign currency? The presence of currency substitution in an economy has important implications for conducting effective monetary and exchange rate policies. It is widely accepted that the phenomenon of currency substitution poses a challenge to the pursuit of a coherent and independent monetary policy. In the section of "Policy Implications", the study examines what the effects of currency substitution on monetary policy and optimal exchange rate policy are.; The conventional empirical study views the degree of the currency substitution process as a function of the interest rate differential, the expected depreciation of the exchange rate, and the lagged dependent variable. This study goes beyond the initial currency substitution literature by explicitly addressing the persistence in the use of foreign currency in Turkey. This hysteresis is modeled through the inclusion of a ratchet variable that implies an asymmetric substitution process between domestic and foreign currency. Finally, the study sheds further light on the relationship between currency substitution and inflation. More specifically, this study examines the direction of causality between inflation uncertainty and currency substitution.