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Currency Substitution in Russia

Fridman Alla () and Verbetsky Aleksey ()
Authors registered in the RePEc Author Service: Alla Friedman

EERC Working Paper Series from EERC Research Network, Russia and CIS

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.

Keywords: Russia; currency substitution; dollarization; welfare analysis; seignorage (search for similar items in EconPapers)
JEL-codes: E41 (search for similar items in EconPapers)
Pages: 35 pages
Date: 2001-12-12
New Economics Papers: this item is included in nep-ifn, nep-mon and nep-tra
References: View references in EconPapers View complete reference list from CitEc
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