Mərkəzi Bank və İqtisadiyyat – N2, 2014
65
substitution even decreased slightly in the second half. It seems that the heart of the
problem lied in the confidence in the national currency.
The empirical findings employing domestic interest rate as an opportunity cost
variable of money holdings are presented in the Table 1 above. The estimated
parameters are not significantly different from the previous case except the
coefficient of substitution. The elasticity of substitution in the first half of the period
now falls to 0.62, but the substitution effect becomes statistically insignificant in the
second half. That is, although there is a strong empirical support for the currency
substitution effect in the pre-boom years, its importance even turns out to be
statistically insignificant in the second half. Also, the discount factor is
(statistically) significantly higher than one which runs contrary to the intuition.
However, as Eichenbaum, et al (1998) indicates that a large value of the discount
factor is a common problem in empirical studies.
We also check for the robustness of our results by using different instrument sets.
We calculate money holdings ratio as the ratio of M2 to foreign deposits in the
second instrument set, . The empirical findings are provided in the Table 2 below.
For the whole period, the estimated coefficients are similar but become less precise
except which is insignificant in the first half.
It is possible that the effect of manat deposits in M2 dominate the overall results. To
test this hypothesis we run the estimation of the empirical model using manat and
foreign currency denominated deposits as inputs in the production of money
services, and short-term interest rate on foreign currency deposits as the opportunity
cost variable. We include manat to foreign currency deposits ratio as a new
instrument in the
.
[INSERT TABLE 2 HERE]
The findings reveal that for the pre-boom years manat deposits have statistically
insignificant share in the production of money services (
) and elasticity of
substitution is relatively smaller. However, for the period of post-boom years the
elasticity of substitution is statistically larger and significant, and manat deposits
enjoy almost half of production of money services.
Empirical evidence show that manat and dollar deposits in both periods are
substitutes though the elasticity of substitution is relatively smaller and the share of
manat deposits is statistically insignificant in the first half. However, as we stated
previously, the magnitude of the elasticity of substitution between cash dollar and
cash manat was very similar in both periods. It seems that an average cash holder
Mərkəzi Bank və İqtisadiyyat – N2, 2014
66
was different from an average manat deposit holder in the pre-boom years. But the
situation reversed in the post boom years and individuals started to treat manat
deposits as an alternative to dollar deposits. That is, the substantial rise in the
volume of strategic currency reserves, increasing confidence in the economy and
the credible fixed exchange regime lead individuals to treat national currency as a
safe haven as well.
[INSERT TABLE 3 HERE]
Moreover, the imposition of the purchasing power parity condition might seem a
strong assumption for the model in the short run. Hence, we also check for the
robustness of our results by replacing exchange rate with foreign price. The
estimation results are presented in the Table 3 above. The empirical findings show
that all parameters except the elasticity of substitution remain almost the same and
their standard errors have not changed significantly in both periods. In the case of
the elasticity of substitution, its value declines to 0.47 in the first half, but it
becomes statistically insignificant in the second half. Though its values differ from
our previous estimation results, this finding is also in line with our previous
findings. That is, although there exist empirical evidence on the currency
substitution between manat and dollar in the first half, its magnitude decreased or
became insignificant in the second half.
Conclusion
In this paper, we empirically document the existence of currency substitution
between Azeri manat and US dollar. The estimation results suggest that in the pre
and post oil boom years those currencies were treated by households as substitutes.
Currency substitution affected the portfolio allocation decisions of cash and deposit
holders, but in the latter case, it was more pronounced in the post boom years.
In the pre-boom years, low interest rate differentials between manat and USD
deposits, and the absence of long-term investment/loan instruments rendered both
borrowers and lenders to store their assets and lend/borrow in a more credible US
dollar. İt seems that the fragile performance of the economy damaged the reputation
of national currency in the early years of transition period.
In contrast, empirical estimation results underscore the rising share of manat
holdings in the money portfolio holdings and comparatively small values of
currency substitution ratios in the post boom years. It is more likely indicating the
strengthening status of the national currency. The windfall of petro dollars to the
country and the respective accumulation in dollar reserves not only restored
Mərkəzi Bank və İqtisadiyyat – N2, 2014
67
confidence in national currency but also strengthened it. The credible fixed
exchange rate policy of the Central Bank affected the attitude of economic agents
and encouraged de-dollarization in the country. This can be one of the underlying
factors behind the lower inflation of the post oil boom years despite the significant
expansion in the money supply. These processes are in the same spirit with the facts
mentioned in the beginning - that increasing stability and inflow of petrodollars
raised the confidence in the national currencies and induced de-dollarization in
Russia and Kazakhstan, two oil rich CIS countries.
References
1.
Agenor, Pierre-Richard and Mohsin S. Khan, 1996, Foreign currency
deposits and the demand for money in developing countries, Journal of
Development Economics 50, pp. 101-118
2.
Eichenbaum M.S., L.P. Hansen and K.J.Singleton, 1988, A Time Series
Analysis of Representative Agents Models of Consumption and Leisure
Choice under Uncertainty, Quarterly Journal of Economics 103, pp. 51 – 78
3.
Feige, Edgar L. and Dean, James, 2004, Dollarization and Euroization in
Transition Countries: Currency Substitution, Asset Substitution, Network
Externalities and Irreversibility, Presented at the Fordham University
International Conference on “Euro and Dollarisation: Forms of Monetary
Union in Integrating Regions” April 5 - 6, 2002, New York
4.
Freidman, Alla and Verbetsky, Alexey, 2001, Currency Substitution in
Russia, EERC, Working Paper 01/05
5.
Harrison, Barry and Vymyatnina, Yulia, 2007, Currency Substitution in a de-
dollarizing economy: The case of Russia, Bank of Finland, BOFIT
Discussion Papers 3
6.
Imrohoroglu, Selahattin, 1994, GMM estimates of Currency Substitution
between the Canadian Dollar and the US Dollar , Journal of Money, Credit
and Banking 26, pp. 792-807
7.
Mongardini, Joannes and Mueller, Johannes, 2000, International Monetary
Fund, Staff Paper 47/2
8.
Oomes, Nienke, 2003, Network Externalities and Dollarization Hysteresis:
The Case of Russia, International Monetary Fund, Working Paper 03/96
9.
Oomes, Nienke and Ohnsorge, Franziska, 2005, Money Demand and
Inflation in Dollarized Economies: The Case of Russia, International
Monetary Fund, Working Paper 05/144
10.
Selcuk, F. 1994, Currency substitution in Turkey, Applied Economics, Vol
26, pp. 509-518
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11.
Tullio, Giuseppe and Ivanova, Nadia, 1998, The demand for money and
currency substitution in Russia during and after hyperinflation: 1992-1996,
Вопросы Теории 2, pp.159-196
12.
Yilmaz, Mesut, Oskenbayev, Yessengali and Abdulla, Kanat, 2009, Currency
Substitution: A Case of Kazakhstan, The William Davidson Institute,
Working Paper 946
APPENDIX
Figure 1. Cash manat in circulation, M0, 2000-2010
Figure 2. USD/AZN exchange rate, 2000-2010
Figure 3. Dollar deposits in the banking sector, 2000-2010
0
1000
2000
3000
4000
5000
6000
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2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
M0, mln AZN
0.7
0.75
0.8
0.85
0.9
0.95
1
1.05
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2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Exchange rate, AZN/USD
Mərkəzi Bank və İqtisadiyyat – N2, 2014
69
Table A1. Descriptive Statistics
pre-boom years
(2001m1-2005m12)
post-boom years
(2006m1-2010m12)
Mean
Std. deviation
Mean
Std. deviation
M0 per capita
44
11
321
157
USD deposit per capita
63
31
209
53
AZN deposit per capita
15
8
161
67
Interest rate on AZN deposits
6.7
1.6
7.5
1.7
Interest rate on USD deposits
5.6
2.2
6.2
1.4
A2. Econometric Estimation Results
Table 1. Estimation results (standard errors are in parentheses)
Parameters
2001-2005
2006-2010
2001-2005
2006-2010
foreign interest rate
domestic interest rate
0.9981
(0.0002)
0.9967
(0.0002)
0.9988
(0.0003)
1.0034
(0.0007)
0.4733
(0.0444)
0.4684
(0.0132)
0.4337
(0.0321)
0.4002
(0.0273)
0.0115
(0.0012)
0.0278
(0.0036)
0.0116
(0.0008)
0.0129
(0.0020)
-0.6585
(0.2288)
-0.6523
(0.1316)
-0.3849
(0.1885)
-0.2235
(0.2712)
J-statistics
9.76
11.32
11.03
9.85
Chi-sq (.025,11)
21.92
Table 2. Estimation results with different Instrument sets (standard errors are in parentheses)
Parameters
2001-2005
2006-2010
2001-2005
2006-2010
0.9982
(0.0002)
0.9967
(0.0002)
0.9982
(0.0002)
0.9967
(0.0002)
0
500
1000
1500
2000
2500
3000
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Dollar deposits, mln AZN
Mərkəzi Bank və İqtisadiyyat – N2, 2014
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0.4565
(0.0339)
0.4848
(0.0213)
0.0093
(0.0105)
0.4262
(0.0129)
0.0126
(0.0013)
0.0271
(0.0037)
0.0066
(0.0009)
0.0273
(0.0037)
0.3304
(0. 4126)
-0.8155
(0.1043)
2.1453
(0.7750)
-0.6828
(0.1327)
J-statistics
10.38
11.82
8.55
11.41
Chi-sq (.025,11)
21.92
Table 3. Estimation results (standard errors are in parentheses)
Parameters
2001-2005
2006-2010
foreign interest rate
0.9981
(0.0002)
0.9967
(0.0002)
0.3861
(0.0488)
0.7188
(0.0254)
0.0104
(0.0008)
0.0171
(0.0023)
1.1388
(0.2288)
-0.2964
(0.2964)
J-statistics
9.55
11.71
Chi-sq (.025,11)
21.92
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