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On the Link between Dollarization and Inflation : Evidence from Turkey

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  • Ilker Domac
  • Mohsen Bahmani-Oskooee

Abstract

This paper investigates the role of dollarisation in the dynamics of inflation in Turkey. Descriptive analysis suggests that, in addition to high inflation and economic instability, institutional factors also played an important role in the evolution of dollarisation in Turkey. The empirical findings corroborate the importance of dollarisation in the dynamics of inflation. The results suggest that shocks to dollarisation initially lead to a decline in the monetary base as the public switches from domestic to foreign money holdings. However, the monetary base increases later on to generate the required inflation tax for a given budget deficit. The findings also indicate that the fiscal authority tries to compensate part of the decline in inflation tax through raising administered prices. As expected, the exchange rate responds positively to shocks to dollarisation owing to the high elasticity of substitution between domestic and foreign currency. Comparative Economic Studies (2003) 45, 306–328. doi:10.1057/palgrave.ces.8100022

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Bibliographic Info

Paper provided by Research and Monetary Policy Department, Central Bank of the Republic of Turkey in its series Discussion Papers with number 0207.

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Date of creation: 2002
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Handle: RePEc:tcb:dpaper:0207

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  1. Ize, Alain & Yeyati, Eduardo Levy, 2003. "Financial dollarization," Journal of International Economics, Elsevier, vol. 59(2), pages 323-347, March.
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  5. Corbo, Vittorio & Landerretche, Oscar & Schmidt-Hebbel, Klaus, 2001. "Assessing Inflation Targeting after a Decade of World Experience," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 6(4), pages 343-68, October.
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  9. Pesaran, H. Hashem & Shin, Yongcheol, 1998. "Generalized impulse response analysis in linear multivariate models," Economics Letters, Elsevier, vol. 58(1), pages 17-29, January.
  10. Pablo Emilio Guidotti & Carlos A. Rodriguez, 1991. "Dollarization in Latin America," IMF Working Papers 91/117, International Monetary Fund.
  11. Lucas, Robert E, Jr, 1996. "Nobel Lecture: Monetary Neutrality," Journal of Political Economy, University of Chicago Press, vol. 104(4), pages 661-82, August.
  12. Vittorio Corbo & Oscar Landerretche & Klaus Schmidt-Hebbel, 2001. "Assessing Inflation Targeting after a Decade of World Experience," Working Papers 51, Oesterreichische Nationalbank (Austrian Central Bank).
  13. Liliana Rojas-Suárez, 1992. "Currency Substitution and Inflation in Peru," IMF Working Papers 92/33, International Monetary Fund.
  14. Honohan, Patrick & Shi, Anging, 2001. "Deposit dollarization and the financial sector in emerging economies," Policy Research Working Paper Series 2748, The World Bank.
  15. Akcay, O. Cevdet & Alper, C. Emre & Karasulu, Meral, 1997. "Currency substitution and exchange rate instability: The Turkish case," European Economic Review, Elsevier, vol. 41(3-5), pages 827-835, April.
  16. Laura Papi & G. C. Lim, 1997. "An Econometric Analysis of the Determinants of Inflation in Turkey," IMF Working Papers 97/170, International Monetary Fund.
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Citations

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Cited by:
  1. Metin-Özcan, Kıvılcım & Us, Vuslat, 2007. "Dedollarization in Turkey after decades of dollarization: A myth or reality?," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 385(1), pages 292-306.
  2. Dominique Torre & Alain Raybaut, 2004. "Unions monétaires, caisses d'émission et dollarisation : les fondements analytiques des systèmes de change « ultra-fixes »," Revue d'Économie Financière, Programme National Persée, vol. 75(2), pages 37-54.
  3. Ayadi, Rym & Arbak, Emrah & Ben-Naceur, Sami & De Groen, Willem Pieter, 2013. "Determinants of Financial Development across the Mediterranean," CEPS Papers 7770, Centre for European Policy Studies.
  4. Levent, Korap, 2006. "An empirical analysis of Turkish inflation (1988-2004): some non-monetarist estimations," MPRA Paper 19630, University Library of Munich, Germany.
  5. Kyriakos C. Neanidis & Christos S. Savva, 2006. "The Effects of Uncertainty on Currency Substitution and Inflation: Evidence from Emerging Economies," The School of Economics Discussion Paper Series 0609, Economics, The University of Manchester.
  6. John J. Seater, 2008. "The Demand for Currency Substitution," Panoeconomicus, Savez ekonomista Vojvodine, Novi Sad, Serbia, vol. 55(4), pages 405-437, December.
  7. Lula G. Mengesha & Mark J. Holmes, 2013. "Does Dollarization Alleviate Or Aggravate Exchange Rate Volatility?," Journal of Economic Development, Chung-Ang Unviersity, Department of Economics, vol. 38(2), pages 99-118, June.
  8. Domac, Ilker, 2004. "Explaining and forecasting inflation in Tukey," Policy Research Working Paper Series 3287, The World Bank.
  9. Faruk Selçuk, 2005. "The Policy Challenge with Floating Exchange Rates: Turkey’s Recent Experience," Open Economies Review, Springer, vol. 16(3), pages 295-312, July.
  10. Oya Pınar Ardıc & Faruk Selcuk, 2006. "The dynamics of a newly floating exchange rate: the Turkish case," Applied Economics, Taylor & Francis Journals, vol. 38(8), pages 931-941.
  11. Levent, Korap, 2007. "Does currency substitution affect exchange rate uncertainty? the case of Turkey," MPRA Paper 20319, University Library of Munich, Germany.
  12. Aysen Arac & Funda Telatar & Erdinc Telatar, 2012. "Investigating the Time Varying Nature of the Link between Inflation and Currency Substitution in the Turkish Economy," Hacettepe University Department of Economics Working Papers 20122, Hacettepe University, Department of Economics.
  13. Yinusa, D. Olalekan, 2009. "Macroeconomic Fluctuations and Deposit Dollarization in Sub-Saharan Africa: Evidence from Panel Data," MPRA Paper 16259, University Library of Munich, Germany, revised 2009.
  14. Ardic, Oya Pinar, 2006. "Output, the Real Exchange Rate, and the Crises in Turkey," MPRA Paper 6099, University Library of Munich, Germany.

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