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Currency Substitution, portfolio Diversification and Money Demand

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  • Miguel Lebre de Freitas

    (Universidade de Aveiro and NIPE)

Abstract

We extend the Thomas (1985) dynamic optimissing model of money demand and currency substitution to the case in which the individual has no access to bonds denominated in foreign currency. We show that in this case the demand for domestic money is influenced by portfolio decisions. Contrary to what defended by the Portfolio Balance Approach to currency substitution, the results obtained in this paper suggest that the significance of an expected exchange rate depreciation term in the demand for domestic money provides a valid test for the present of curency substitution. The results also suggest that, in countries facing monetary instability and currency substitution, restricting the availability of interest-bearning assets denominated in foreign currency may have a destabilising impact on the money demand.

Suggested Citation

  • Miguel Lebre de Freitas, 2004. "Currency Substitution, portfolio Diversification and Money Demand," NIPE Working Papers 9/2004, NIPE - Universidade do Minho.
    • Handle: RePEc:nip:nipewp:9/2004
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    Cited by:

    1. Miguel Lebre de Freitas, 2023. "Forecasting inflation with excess liquidity and excess depreciation: the case of Angola," Economic Change and Restructuring, Springer, vol. 56(1), pages 473-514, February.
    2. Miguel Lebre de Freitas, 2006. "Currency Substitution and Money Demand in Euroland," Atlantic Economic Journal, Springer;International Atlantic Economic Society, vol. 34(3), pages 275-287, September.
    3. Ingrid Groessl & Ulrich Fritsche, 2006. "The Store-of-Value-Function of Money as a Component of Household Risk Management," Macroeconomics and Finance Series 200606, University of Hamburg, Department of Socioeconomics.
    4. Harrison, Barry & Vymyatnina, Yulia, 2007. "Currency substitution in a de-dollarizing economy: the case of Russia," BOFIT Discussion Papers 3/2007, Bank of Finland Institute for Emerging Economies (BOFIT).
    5. Ivan Milenković & Milivoje Davidović, 2013. "Determinants of Currency Substitution/Dollarization – The Case of the Republic of Serbia," Journal of Central Banking Theory and Practice, Central bank of Montenegro, vol. 2(1), pages 139-155.
    6. K. Azim Özdemir & Mesut Saygılı, 2013. "Economic uncertainty and money demand stability in Turkey," Journal of Economic Studies, Emerald Group Publishing Limited, vol. 40(3), pages 314-333, July.
    7. Caroline Duburcq, 2010. "The Impact of Exchange Rate Regime on Interest Rates in Latin America," Latin American Journal of Economics-formerly Cuadernos de Economía, Instituto de Economía. Pontificia Universidad Católica de Chile., vol. 47(135), pages 91-124.
    8. Caroline Duburcq & Eric Girardin, 2010. "Domestic and external factors in interest rate determination: the minor role of the exchange rate regime," Economics Bulletin, AccessEcon, vol. 30(1), pages 624-635.
    9. repec:ebl:ecbull:v:30:y:2010:i:1:p:624-635 is not listed on IDEAS
    10. repec:cbk:journl:v:1:y:2013:i:3:p:139-155 is not listed on IDEAS
    11. Miguel Lebre de Freitas, 2014. "On inflation and money demand in a portfolio model with shopping costs," NIPE Working Papers 13/2014, NIPE - Universidade do Minho.
    12. Lebre DE Freitas, Miguel, 2022. "International currency substitution and the demand for money in the euro area," Economic Modelling, Elsevier, vol. 117(C).
    13. Buffie, Edward F. & Airaudo, M. & Zanna, Felipe, 2018. "Inflation targeting and exchange rate management in less developed countries," Journal of International Money and Finance, Elsevier, vol. 81(C), pages 159-184.
    14. Mr. Marco Airaudo & Mr. Edward F Buffie & Luis-Felipe Zanna, 2016. "Inflation Targeting and Exchange Rate Management In Less Developed Countries," IMF Working Papers 2016/055, International Monetary Fund.

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    More about this item

    Keywords

    Money Demand; currency Substitution; Dollarisation; Portfolio Choice.;
    All these keywords.

    JEL classification:

    • E41 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Demand for Money
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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