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Dollarization, Inflation Volatility and Underdeveloped Financial Markets in Transition Economies

  • Piontkovsky Ruslan

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    The paper analyzes the phenomenon of dollarization in a sample of transition economies: Ukraine, Russia, Poland, Czech Republic, Romania, Slovenia, Croatia, Latvia, and Lithuania. Using the Thomas' portfolio balance model, the author tests how the degree of dollarization depends on the relative returns on financial assets, inflation volatility, and financial market development. The main conclusion from the analysis is that relative returns on assets (bank deposits in the domestic currency relative to deposits in foreign currencies) and inflation volatility have a significant effect on dollarization. The effect of financial market development is also captured, albeit indirectly, as dollarization is found to be dependent on the country’s balance of trade (the inflow of foreign currency).

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    File URL: https://eercnetwork.com/default/download/creater/working_papers/file/6cea87967a761638cfb574148c0830b182e3c9b4.pdf
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    Paper provided by EERC Research Network, Russia and CIS in its series EERC Working Paper Series with number 03-02e.

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    Length: 28 pages
    Date of creation: 21 May 2003
    Date of revision:
    Handle: RePEc:eer:wpalle:03-02e
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    1. Vetlov, Igor, 2001. "Dollarization in Lithuania : An econometric approach," BOFIT Discussion Papers 1/2001, Bank of Finland, Institute for Economies in Transition.
    2. Calvo, Guillermo A & Rodriguez, Carlos Alfredo, 1977. "A Model of Exchange Rate Determination under Currency Substitution and Rational Expectations," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 617-25, June.
    3. Vegh, Carlos A., 1989. "The optimal inflation tax in the presence of currency substitution," Journal of Monetary Economics, Elsevier, vol. 24(1), pages 139-146, July.
    4. John Kareken & Neil Wallace, 1981. "On the Indeterminacy of Equilibrium Exchange Rates," The Quarterly Journal of Economics, Oxford University Press, vol. 96(2), pages 207-222.
    5. Bufman, Gil & Leiderman, Leonardo, 1993. "Currency Substitution under Nonexpected Utility: Some Empirical Evidence," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 25(3), pages 320-35, August.
    6. Calvo, Guillermo & Vegh, Carlos, 1992. "Currency Substitution in Developing Countries: An Introduction," MPRA Paper 20338, University Library of Munich, Germany.
    7. Cuddington, John T. & Cuddington, John T., 1983. "Currency substitution, capital mobility and money demand," Journal of International Money and Finance, Elsevier, vol. 2(2), pages 111-133, August.
    8. Eduardo Borensztein & Andrew Berg, 2000. "The Choice of Exchange Rate Regime and Monetary Target in Highly Dollarized Economies," IMF Working Papers 00/29, International Monetary Fund.
    9. Stephen J. Turnovsky, 2000. "Methods of Macroeconomic Dynamics, 2nd Edition," MIT Press Books, The MIT Press, edition 2, volume 1, number 0262201232, March.
    10. Sarajevs, Vadims, 2000. "Econometric analysis of currency substitution : A case of Latvia," BOFIT Discussion Papers 4/2000, Bank of Finland, Institute for Economies in Transition.
    11. van Aarle, B. & Budina, N., 1995. "Currency substitution in Eastern Europe," Discussion Paper 1995-2, Tilburg University, Center for Economic Research.
    12. Miles, Marc A, 1978. "Currency Substitution, Flexible Exchange Rates, and Monetary Independence," American Economic Review, American Economic Association, vol. 68(3), pages 428-36, June.
    13. Eduardo Levy Yeyati & Alain Ize, 1998. "Dollarization of Financial Intermediation; Causes and Policy Implications," IMF Working Papers 98/28, International Monetary Fund.
    14. Fridman Alla & Verbetsky Aleksey, 2001. "Currency Substitution in Russia," EERC Working Paper Series 01-05e, EERC Research Network, Russia and CIS.
    15. Liviatan, Nissan, 1981. "Monetary Expansion and Real Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, vol. 89(6), pages 1218-27, December.
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