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Currency Substitution in Russia

Author

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  • Fridman Alla

    ()

  • Verbetsky Aleksey

    ()

Abstract

Due to high inflation and the lack of financial instruments, the Russian economy is currently highly dollarized. The share of dollars in the total amount of cash circulating in the Russian economy constitutes about 80%. What is the degree of this currency substitution phenomenon? What are the implications of dollarization for the possibility of inflationary financing of the budget deficit and for welfare? These questions are studied by the authors using estimations obtained from the Ramsey – Lucas model, which uses two types of money in the utility function. In this paper, the authors use dynamic money in the utility function model, in which money services are produced both by domestic and foreign money balances, to empirically investigate currency substitution between Russian rubles and U.S. dollars in the Russian economy during the period 1995 to mid 2000. Data supports the hypothesis that foreign currency enters as a variable in the representative consumer's utility function. Our findings indicate considerable currency substitution: most estimates of elasticity of substitution are between 2 and 3. Based on estimated parameters, it is shown that simulated steady state seignorage revenues are close to actual ones for different inflationary periods. The effect of a change in the degree of dollarization on the seignorage/GDP ratio appears to be strong if the economy is highly dollarized. The estimates also demonstrate a sizable welfare impact of inflation and dollarization.

Suggested Citation

  • Fridman Alla & Verbetsky Aleksey, 2001. "Currency Substitution in Russia," EERC Working Paper Series 01-05e, EERC Research Network, Russia and CIS.
  • Handle: RePEc:eer:wpalle:01-05e
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Marco Airaudo & Edward F Buffie & Luis-Felipe Zanna, 2016. "Inflation Targeting and Exchange Rate Management In Less Developed Countries," IMF Working Papers 16/55, International Monetary Fund.
    2. Olga Aslanidi, 2008. "Dollarization in Transition Economies: New Evidence from Georgia," CERGE-EI Working Papers wp366, The Center for Economic Research and Graduate Education - Economics Institute, Prague.
    3. Isakova, Asel, 2010. "Currency substitution in the economies of Central Asia : how much does it cost?," BOFIT Discussion Papers 14/2010, Bank of Finland, Institute for Economies in Transition.
    4. William C. Gruben & Darryl McLeod, 2004. "Currency competition and inflation convergence," Center for Latin America Working Papers 0204, Federal Reserve Bank of Dallas.
    5. Ralph Sueppel, 2002. "Russias financial markets boom, crisis and recovery 1995-2001, Lessons for Emerging Markets Investors," Macroeconomics 0206002, EconWPA.
    6. Olga Loiseau-Aslanidi, 2012. "Dollarization in Emerging Markets: Evidence from Georgia," Emerging Markets Finance and Trade, Taylor & Francis Journals, vol. 48(3), pages 70-84, May.
    7. Shinkevich Andrey, 2002. "Dollarization Hysteresis in Russia," EERC Working Paper Series 00-087e, EERC Research Network, Russia and CIS.
    8. John Duffy & Maxim Nikitin, 2004. "Dollarization Traps," Econometric Society 2004 Latin American Meetings 196, Econometric Society.
    9. Asel Isakova, 2010. "Currency Substitution in the Economies of Central Asia: How Much Does it Cost?," Chapters,in: The Euro and Economic Stability, chapter 9 Edward Elgar Publishing.
    10. Piontkovsky Ruslan, 2003. "Dollarization, Inflation Volatility and Underdeveloped Financial Markets in Transition Economies," EERC Working Paper Series 03-02e, EERC Research Network, Russia and CIS.
    11. Olga Loiseau-Aslanidi, 2012. "Dollarization in Emerging Markets: Evidence from Georgia," Emerging Markets Finance and Trade, Taylor & Francis Journals, vol. 48(3), pages 70-84, May.
    12. repec:eee:jimfin:v:81:y:2018:i:c:p:159-184 is not listed on IDEAS

    More about this item

    Keywords

    Russia; currency substitution; dollarization; welfare analysis; seignorage;

    JEL classification:

    • E41 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Demand for Money

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