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The Effects of Uncertainty on Currency Substitution and Inflation: Evidence from Emerging Economies

  • K C Neanidis
  • C S Savva

This paper examines the effects of inflation and currency substitution volatility on the average rates of inflation and currency substitution for twelve emerging market economies. Using a bivariate GARCH-in-Mean model, which accommodates for asymmetric and spillover effects of inflation and currency substitution innovations on their volatilities, we find that for the majority of the countries in the sample the variability of inflation exerts a positive influence on both the average rates of inflation and currency substitution. Similarly, higher uncertainty in currency substitution displays enhancing effects on inflation and currency substitution. These results indicate an alternative avenue that stresses the importance of currency substitution for the conduct of monetary policy in terms of price stability, and provide an additional explanation to the phenomenon of dollarization hysteresis.

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File URL: http://www.socialsciences.manchester.ac.uk/medialibrary/cgbcr/discussionpapers/dpcgbcr71.pdf
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Paper provided by Economics, The Univeristy of Manchester in its series Centre for Growth and Business Cycle Research Discussion Paper Series with number 71.

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Length: 25 pages
Date of creation: 2006
Date of revision:
Handle: RePEc:man:cgbcrp:71
Contact details of provider: Postal: Manchester M13 9PL
Phone: (0)161 275 4868
Fax: (0)161 275 4812
Web page: http://www.socialsciences.manchester.ac.uk/subjects/economics/our-research/centre-for-growth-and-business-cycle-research/
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  1. Pablo Emilio Guidotti & Carlos A. Rodriguez, 1991. "Dollarization in Latin America; Gresham's Law in Reverse?," IMF Working Papers 91/117, International Monetary Fund.
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  13. Calvo, Guillermo & Vegh, Carlos, 1992. "Currency Substitution in Developing Countries: An Introduction," MPRA Paper 20338, University Library of Munich, Germany.
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  16. Don Bredin & Stilianos Fountas, 2004. "Macroeconomic Uncertainty and Macroeconomic Performance: Are they related?," Money Macro and Finance (MMF) Research Group Conference 2004 51, Money Macro and Finance Research Group.
  17. Oleh Havrylyshyn & Christian H Beddies, 2003. "Dollarisation in the Former Soviet Union: from Hysteria to Hysteresis," Comparative Economic Studies, Palgrave Macmillan, vol. 45(3), pages 329-357, September.
  18. Lebre de Freitas, M., 2004. "The dynamics of inflation and currency substitution in a small open economy," Journal of International Money and Finance, Elsevier, vol. 23(1), pages 133-142, February.
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  23. Ajay Tandon & Yong Wang, 2003. "Confidence in Domestic Money and Currency Substitution," Economic Inquiry, Western Economic Association International, vol. 41(3), pages 407-419, July.
  24. Shields, KalvInder & Kevin B Grier & Olan T Henry & Nilss Olekalns, 2003. "The Asymmetric Effects of Uncertainty on Inflation and Output Growth," Royal Economic Society Annual Conference 2003 187, Royal Economic Society.
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  26. Lange, Carsten & Sauer, Christine, 2005. "Dollarization in Latin America: seigniorage costs and policy implications," The Quarterly Review of Economics and Finance, Elsevier, vol. 45(4-5), pages 662-679, September.
  27. Barnett, Richard C. & Ho, Mun S., 1996. "Sunspots, currency substitution, and inflationary finance," Journal of International Economics, Elsevier, vol. 41(1-2), pages 73-93, August.
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