Abstract
This paper presents new evidence on the dynamics of dollarisation and euroisation for 25 transition countries. Estimates of the amount of foreign currency in circulation (FCC) in transition countries are used to develop a new comprehensive dollarisation index (CDI) and separate indices of currency substitution (CSI) and asset substitution. When the CDI is compared to the traditional dollarisation index that relies solely on foreign currency deposits as a proxy for the extent of dollarisation, I find that the comprehensive dollarisation measure provides a more complete picture of the extent of de facto dollarisation and euroisation, and that it better reflects the separate influences of currency substitution and asset substitution. I find that the dynamic evolution of currency substitution and asset substitution in transition countries is both more variable and complex than is usually believed to be the case. These new dollarisation indicators enable researchers to examine the causes of the dollarisation process and its tendency to lead to irreversibility (hysteresis). Moreover, the currency substitution and asset substitution indices shed light on the dynamic consequences of these processes for the effectiveness of monetary policy. Finally, the new estimates of FCC make possible the measurement of effective currency/deposit ratios that can be used to develop new estimates of the size and growth of underground economies in transition countries.
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Notes
Earlier efforts by Feige et al. (2002) and Feige and Dean (2002) reported initial unadjusted point in time estimates of dollarisation in various countries.
The currencies reported in the surveys of the Austrian National Bank include Austrian schillings (AST), Deutsch marks (DM) and Swiss Francs (SW) in addition to US dollar (US) holdings.
These temporal estimates of FCC have been employed by Feige et al. (2003) to analyse the consequences of network externalities and the hysteresis problem for the case of Argentina, and in the study by Oomes (2003) for Russia.
Feige et al. (2003) estimate that for Argentina, a shift from high dollarisation equilibrium to low-level dollarisation equilibrium would require a sustained 35% appreciation of the currency.
A more detailed description of these data can be found in Feige (1996, 1997).
The initial proxy included only inflows and outflows of $100 bills from the New York FED office that accounts for a substantial portion of the currency sent abroad.
A proposal to the European Central Bank to monitor carefully the historic introduction of the Euro by setting up an ECI-type programme that would record the gross outflows and inflows of euros and returning legacy currencies from outside the EMU was ultimately rejected by the ECB. However, with the support of the IMF and the Croatian National Bank, a number of CEE central banks have undertaken independent efforts to survey their commercial banks in an effort to collect data on the amounts of euros in circulation.
The author is indebted to the Austrian National Bank for providing its survey estimates.
The appropriateness of this five-fold adjustment is confirmed by independent estimates of the amount of FCC in circulation in Croatia. The Croatian National Bank monitored flows of foreign currency into and out of the banking system during and after the Euro conversion process and estimated that the holdings of FCC in Euros was 3.1 billion (Kraft, 2002). A five-fold blow-up of the Austrian National Bank (ONB) survey estimate of non-dollar FCC holdings in Croatia yields a corresponding estimate 3.05 billion. These estimates are also within the range of indirect estimates of FCC in Croatia based on money demand and denomination displacement methods (Feige et al., 2003). Since Croatia is the only country for which the appropriateness of the blow-up factor could be independently tested, we employ the actual survey results without the blow-up factor for all CEE countries covered by the ONB survey.
The data reported for Croatia, Czech Republic, Hungary, Slovenia and the Slovak Republic include both dollar holdings and the holdings of European legacy currencies as estimated from survey data obtained from the Austrian Central Bank. These are the only countries for which independent estimates of European legacy currencies are available. The results reported for all other countries therefore include only estimated holdings of US dollars.
Some foreign banknotes may be hoarded for long periods and might therefore be considered largely as a store of value. When the fraction of FCC that is in long-term hoards can be estimated, it should be treated as a store of value and included in the asset substitution index rather than the currency substitution index.
When data on M2 and/or LTD are unavailable, but measures of QM are available, the ASI can be approximated by the ratio of FCD to total deposits, which equals LDD+QM. These two measures tend to be closely correlated. However, just as some FCC is used for hoards, some portion of FCD may be used for transactions purposes. Where this transaction component can be determined, the appropriate empirical treatment would be to include it in the CSI rather than the ASI.
This analysis is contingent on the caveats mentioned in footnotes 11 & 12.
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Acknowledgements
I thank Paul Wachtel and Vedran Šošić for helpful comments and suggestions.
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Feige, E. Dynamics of Currency Substitution, Asset Substitution and De facto Dollarisation and Euroisation in Transition Countries. Comp Econ Stud 45, 358–383 (2003). https://doi.org/10.1057/palgrave.ces.8100019
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DOI: https://doi.org/10.1057/palgrave.ces.8100019
Keywords
- dollarisation
- euroisation
- transition economies
- currency substitution
- asset substitution
- underground economies
- foreign currency
- network externalities
- irreversibility