Batten, Dallas S., and R.W. Hafer, “Currency Substitution: A Test of Its Importance,” Review, Federal Reserve Bank of St. Louis (St. Louis), Vol. 66 (August-September 1984), pp. 5–11.
Batten, Dallas S., and R.W. Hafer, “Money, Income, and Currency Substitution: Evidence from Three Countries,” Review, Federal Reserve Bank of St. Louis (St. Louis), Vol. 67 (May 1985), pp. 27–35.
Batten, Dallas S., and R.W. Hafer, “Impact of International Factors on U.S. Inflation: An Empirical Test of the Currency Substitution Hypothesis,” Southern Economic Journal (Chapel Hill, North Carolina), Vol. 53 (October 1986), pp. 400–12.
Bordo, Michael D., and Ehsan U. Choudhuri, “Currency Substitution and the Demand for Money: Some Evidence for Canada,” Journal of Money, Credit and Banking (Columbus, Ohio), Vol. 14 (February 1982), pp. 48–57.
Brillembourg, Arturo, and Susan M. Schadler, “A Model of Currency Substitution in Exchange Rate Determination, 1973-78,” Staff Papers, International Monetary Fund (Washington), Vol. 26 (September 1979), pp. 513–42.
Canto, Victor A., “Monetary Policy, ‘Dollarization,’ and Parallel Market Exchange Rates: The Case of the Dominican Republic,” Journal of International Money and Finance (Guildford, England), Vol. 4 (December 1985), pp. 507–21.
Daniel, B.C., and H.O. Fried, “Currency Substitution, Postal Strikes, and Canadian Money Demand,” Canadian Journal of Economics (Toronto), Vol. 16 (November 1983), pp. 612–24.
Dodsworth, J., Mohamed A. El-Erian, and D. Hammann, “Foreign Currency Deposits in Developing Countries—Origins and Economic Implications,” IMF Working Paper WP/87/12 (Washington, March 1987).
El-Erian, Mohamed A., “Foreign Currency Deposits in LDCs,” Finance & Development (Washington), Vol. 24 (December 1987), pp. 38–40.
Fischer, Stanley, “Seigniorage and the Case for a National Money,” Journal of Political Economy (Chicago), Vol. 90 (April 1982), pp. 295–313.
Girton, Lance, and D. Roper, “Theory and Implications of Currency Substitution,” Journal of Money, Credit and Banking (Columbus, Ohio), Vol. 13 (February 1981), pp. 12–30.
Gruben, William C., and Patrick J. Lawler, “Currency Substitution: The Use of Dollar Coin and Currency in the Texas Border Areas of Mexico,” Economic Review, Federal Reserve Bank of Dallas (Dallas), July 1983, pp. 10–20.
Husted, Steven Leslie, “The Theory and Empirical Estimation of Currency Substitution” (Ph.D. dissertation; East Lansing: Michigan State University, 1980).
Khan, Mohsin S., and C.L. Ramirez-Rojas, “Currency Substitution and Government Revenue from Inflation,” (unpublished; Washington: International Monetary Fund, September 1984).
Leite, Sergio Pereira, Cyrus Sassanpour, and Harry Snoek, “Yemen Arab Republic: Issues in the Transition from a Traditional to a Modern Financial System” (unpublished; Washington: International Monetary Fund, November 1986).
Marquez, J. (1985a), “Currency Substitution and Economic Monetary Aggregates: The U.S. Case,” Economics Letters (Amsterdam), Vol. 19 (No. 4), pp. 363–67.
Marquez, J. (1985b), “Money Demand in Open Economies: A Currency Substitution Model for Venezuela,” International Finance Discussion Paper 265 (Washington: Board of Governors of the Federal Reserve System, October 1985).
Melvin, M., “Currency Substitution and Western European Monetary Unification,” Economica (London), Vol. 52 (February 1985), pp. 79–91.
Miles, M.A., “Currency Substitution, Flexible Exchange Rates, and Monetary Independence,” American Economic Review (Nashville, Tennessee), Vol. 68 (June 1978), pp. 428–36.
Ortiz, Guillermo, “Currency Substitution in Mexico: The Dollarization Problem,” Journal of Money, Credit and Banking (Columbus, Ohio), Vol. 15 (May 1983), pp. 174–85.
Poloz, Stephen S., “Currency Substitution and the Precautionary Demand for Money,” Journal of International Money and Finance (Guildford, England), Vol. 5 (March 1986), pp. 115–24.
Ramirez-Rojas, C.L., “Currency Substitution in Argentina, Mexico, and Uruguay,” Staff Papers, International Monetary Fund (Washington), Vol. 32 (December 1985), pp. 629–67.
Tanzi, Vito, and Mario I. Blejer, “Inflation, Interest Rate Policy, and Currency Substitution in Developing Economies: A Discussion of Some Major Issues,” World Development (Oxford), Vol. 10 (September 1982), pp. 781–89.
Mr. El-Erian, an economist in the Middle Eastern Department, is a graduate of Cambridge University and received his doctorate from Oxford University.
The paper draws on background work undertaken in preparing an earlier paper on foreign currency deposits in developing countries (Dodsworth, El-Erian, and Hammann (1987))
The type of currency substitution under consideration has been referred to in the literature as “nonsymmetrical” because residents’ demand for a “stronger” currency is not accompanied by a demand for the “weaker” currency by agents abroad.
Analysis of the various aspects of this problem can be found in Batten and Hafer (1985), Brillembourg and Schadler (1979), and Fasano-Filho (1986).
A discussion of these issues is contained in Dodsworth, El-Erian, and Hammann (1987) and in El-Erian (1987).
In this approach, both domestic and foreign currency balances enter the agents’ utility functions. Such an approach is used in Bordo and Choudhuri (1982).
See Brillembourg and Schadler (1979). where the choice of assets in agents’ portfolio decisions depends on the mean and variance of the returns.
In this approach, explicit account is taken of expenditure uncertainty as a motive for holding money. See Poloz (1986).
The a priori sign on Φ depends on the exact specification of institutional and political factors. For example, a positive relationship would be expected if the variable is specified in such a way that an increase denotes greater political uncertainty.
As of June 1986, these holdings amounted to US$3.0 billion for Egypt and US$360 million for the Y.A.R.
More specifically, the coefficients of correlation between developments in these two types of deposits were estimated at 0.91 and 0.90 for Egypt and the Y.A.R., respectively.
Around three quarters of the recorded money stock in the Y.A.R., for example, is held outside the banking system in the form of currency in the hands of the nonbanking public.
This argument is also valid for the other explanatory variables—that is, those capturing changes in institutional and political factors.
In local currency terms, the deposits grew at an annual rate of 42 percent during this period.
The two types of deposits grew by annual rates of 30 percent and 44 percent, respectively, when measured in local currency.
The growth rate of these deposits, in local currency terms, amounted to 42 percent annually.
Such an extension would require, among other things, a shift of emphasis toward longer-term institutional factors (for example, the pace oi monetization and spread of banking habits) as well as toward more general issues relating to the level and structure of overall economic and financial development (for example, changes in the “openness” of the economy).
Defined as the three-month LIBOR (London interbank offered rate) U.S. dollar rate relative to the domestic rate of interest on three-month local currency bank deposits. Movements in these rates were found to correspond closely to those in rates on other bank maturities.
Based on the estimated coefficient of determination, adjusted for degrees of freedom, reported in the table.
As proxied by a dummy variable specified to take into account the sudden increase in political uncertainty associated with the assassination of President Sadat in October 1981.
This specification differs in an important way from that adopted in a number of previous quantitative studies in this area. Previous studies have tended to take account only of the absolute level of the expected exchange rate, whereas the present study relates changes in currency substitution to the deviation of the expected rate from the relevant spot rate.
The use of the more limited ex change-rate-expectations proxy based on the absolute level of the rate, as was done in the study by Ramirez-Rojas (1985), yields an “elasticity” for Egypt similar to that estimated for Uruguay. The estimated elasticity for Egypt is also similar to that found by Ramirez-Rojas for Mexico in the specification in which the level of the future price for Mexican pesos was used as the proxy for exchange rate expectations.
Several other country studies appear to have omitted, a priori, the interest rate term in estimating the determinants of currency substitution.
In the case of the Y.A.R., the specification of the “institutional term” is such as to take account of the major banking and exchange system changes of 1983/84. As noted earlier, these changes effectively reduced the foreign ex-change resources for import purposes available through banking channels, there-by increasing the attractiveness of “own-resource finance” for transaction purposes. Details of the changes are contained in Leite, Sassanpour, and Snoek (1986).
In view of the relatively more rigid nature of the exchange system in the Y.A.R. in the period under consideration, expected exchange rate develop-ments were derived on the basis of the lagged value of the future formal rate relative to the spot formal rate.
Specifications based on the more limited proxy of exchange rate expectations yielded an elasticity of 2.0, which is similar to those estimated by Ramirez-Rojas (1985) for Argentina (which were in the range 1.5-2.1).