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The micro-foundations of an open economy money demand: An application to the Central and Eastern European countries

Claudiu Albulescu (), Dominique Pépin () and Stephen Miller ()

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Abstract: This paper investigates and compares currency substitution between the currencies of Central and Eastern European (CEE) countries and the euro. In addition, we develop a model with microeconomic foundations, which identifies difference between currency substitution and money demand sensitivity to exchange rate variations. More precisely, we posit that currency substitution relates to money demand sensitivity to the interest rate spread between the CEE countries and the euro area. Moreover, we show how the exchange rate affects money demand, even absent a currency substitution effect. This model applies to any country where an international currency offers liquidity services to domestic agents. The model generates empirical tests of long-run money demand using two complementary cointegrating equations. The opportunity cost of holding the money and the scale variable, either household consumption or output, explain the long-run money demand in CEE countries.

Keywords: money demand; open economy model; currency substitution; cointegration; CEE countries (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-eec, nep-mon and nep-tra
Date: 2016-07-20
Note: View the original document on HAL open archive server: https://hal.archives-ouvertes.fr/hal-01348842v3
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Working Paper: The micro-foundations of an open economy money demand: An application to the Central and Eastern European countries (2017) Downloads
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