Currency Substitution, Unoffical Dollarization and Estimates of Foreign Currency Held Abroad: The Case of Croatia

This paper employs new estimates of US currency held abroad to determine the degree of unofficial or de facto dollarization that has taken place in key countries around the world. Empirical estimates of foreign currency in circulation permits refined definitions of unofficial dollarization indices as well as new measures of currency and asset substitution and bank credibility indices. The new unofficial dollarization indices are compared to the commonly used IMF dollarization measures and are shown to be superior. The paper then examines the problem of estimating the unobserved amounts of European currencies [particularly the Deutsche mark (DM)] that circulate as second currencies in many Central and Eastern European nations. A denomination displacement method and a money demand method are employed to estimate the unobserved quantity of DM circulating in Croatia. The final section calls attention to the importance of monitoring the historic experiment that will take place when the Euro currency is introduced on January 1, 2002. In particular, it calls for a data collection mechanism capable of measuring the extent to which the new Euro currency substitutes for the local currencies of Central and Eastern European transition countries.