Academy of Economic Studies Doctoral School of Finance and Banking

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Academy of Economic StudiesDoctoral School of
Finance and Banking

• CURRENCY SUBSTITUTION
• IN ROMANIA
• MSc Student Ciprian Dascalu
• Supervisor Professor Moisa Altar

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THEORETICAL BACKGROUND

• Definitions
• - Currency substitution
• - Currency substitutability
• Dollarisation or Currency Substitution
• Theoretical models
• - cash-in-advance models
• - transaction-costs models
• - ad-hoc models

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EMPIRICAL BACKGROUND

• Money demand functions for domestic and foreign
  currency are part of a sequential portfolio
  balance model
• Two-period portfolio balance model
• Models dealing with representative agent dynamic
  optimization problem
• Money demand models including ratchet effect to
  account for hysteresis
• Pros and Cons of currency substitution

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DEPENDENT VARIBLES

• Total stock of money in domestic currency
  (M_ROL1)
• The total stock of domestic money in banking
  system (M_ROL2), since there is no reliable data
  on foreign currency in circulation
• The ratio of foreign currency deposits and brad
  money (CS1)
• The proportion of foreign deposits in total term
  deposits (CS2), considering that foreign currency
  deposits are primarily hold for store of value
  proposes
• The ratio between domestic and foreign currency
  (CS3) to inspect the substitution between
  domestic and foreign currency deposits.
• All dependent variables are in logarithms.

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EXPLANATORY VARIABLES

• A scale variable, the industrial production
  (IPI), in logarithm
• The own return (marginal) of domestic money, the
  deposit interest rate for non-banking clients
  (DR)
• The opportunity cost of holding money, the return
  on treasury bills (TBR)
• The inflation rate since real assets represent an
  alternative to money holding (INFLATION)
• Exchange rate depreciation against a basket
  comprised of (60 EURO and 40 USD) (D_BASKET) as
  the relative cost of holding domestic money
  instead of foreign currency
• The past peak values of the exchange rate
  (R_BASKET) and the past peak values of currency
  substitution ratios (R_CS), to account for the
  ratchet effect, both expressed in logarithms.

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MODEL USED

• Portfolio Balance Model a version of Branson
  and Henderson (1985) to investigate currency
  substitutability, this model implies a negative
  sign associated to depreciation rate as an
  evidence that domestic currency could be
  substituted by a foreign currency
• Analysis of the currency substitution as a ratio
  without imposing restriction reflecting a
  particular money demand theory, since foreign
  deposits have a significant store of value role
• The possibility of an asymmetric reaction of
  foreign currency holdings to its main
  determinants.

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METHODOLOGY

• ECMs proved to be a useful tool for estimation
  of money demand functions, along with the long
  run relation given by cointegration using
  Johansen procedure
• Data span is 199601 200212
• Data is not seasonally adjusted (such
  pre-filtering may affect the short-run dynamics)
• Except the depreciation rate and the rate of
  inflation which are probably I(0), the rest of
  variable are I(1), they shouldn't be excluded of
  the cointegration vector (Dickey and Rossana
  (1994), Harris (1995)).

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CURRENCY SUBSTITUTABILITY
Standard errors in ( ) t-statistics in .
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STABILITY TESTS
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STABILITY TESTS
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CURRENCY SUBSTITUTABILITY
Standard errors in ( ) t-statistics in .
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STABILITY TESTS
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STABILITY TESTS
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EVIDENCE THAT DOMESTIC CURRENCY HAS THE ABILITY
OF BEING SUBSTITUTED
 
The null hypothesis is that the coefficient
associated to exchange rate depreciation is zero.
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RESTRICTION IN LINE WITH THE QUANTITATIVE THEORY
OF MONEY
The null hypothesis is that the coefficient
associated to the scale variable is one.
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WEAK EXOGEINITY
The null hypothesis is that there is weak
exogeneity. The deposit rate (after the sharp
decline in money demand after 1997, the NBR
stimulated its recovery through a rise in the
level of interest rates) and the depreciation
basket (demonetisation of the economy raise the
demand for foreign currency) adjust to the
disequilibria in the cointegration vector.
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CURRENCY SUBSTITUTION
Standard errors in ( ) t-statistics in .
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HYSTERESIS
Standard errors in ( ) t-statistics in .
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CONCLUSIONS

• The demand for domestic currency is sensitive to
  exchange rate depreciation, thus the national
  money could be replaced by foreign currency.
• Raising the interest rate on deposits would be a
  solution for reverting the currency substitution
  process. But there were periods with negative
  real interest rate.
• In Romania the substitution process was rather
  encouraged since the reserve requirements
  established a lower rate for foreign currency
  deposits until November 2002 (when the rate of
  reserve requirements was set at 25 for deposits
  in foreign exchange and 18 for deposits in
  national currency, with a view to effectively
  discourage further dollarisation).

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