Currency Substitution in a De-Dollarizing Economy: The Case of Russia

Abstract

Currency substitution, the use of foreign money to finance transactions between domestic residents, is a common feature of emerging market economies. Currency substitution reduces the stability of money demand functions in ways that can seriously undermine central bank credibility and its efforts to implement monetary policy. Most transition economies, including Russia, experienced widespread currency substitution in the early phase of transition. Following Russia's financial meltdown in 1998, its monetary authorities introduced a raft of changes that substantially improved the stability and performance of the macroeconomy and reduced currency substitution. This paper investigates currency substitution in the Russian economy in the post-crisis period of 1999-2005. Several measures of currency substitution and different modelling frameworks consistently suggest an on-going decline in currency substitution, a shift that has important implications for Russian monetary policy.

Currency Substitution in the Economies of Central Asia: How Much Does it Cost?

“…They show that small increases in dollarization have resulted in large seigniorage losses in Israel. Harrison and Vymyatnina (2007) argue that currency substitution can also preclude a government from using an in ationary tax to nance its expenditure programs, as the spending power is limited by the willingness of domestic residents to hold domestic currency. They claim that foreign currency cash transactions can encourage tax evasion and shift the economy to underground activities.…”

“…Mongardini and Mueller (1999) examine currency substitution in the Kyrgyz economy. More recently, Harrison and Vymyatnina (2007) have used this methodology to study currency substitution in Russia.…”

“…Furthermore, this approach is suitable for calculating seigniorage revenue in the framework of the present model's setup and is simple in computation. 25 The monetary concept determines seigniorage as follows:…”

“…26 The RRA parameter is assumed to be 0, since it was not estimated precisely and its estimated value was negative in some cases. In the 25 Though monetary de nition of seigniorage is the most widespread concept of seigniorage, other de nitions can be found in the recent literauture. Fiscal seigniorage refers to the yield on the counterparts of the monetary base after deduction of costs.…”

Russia, EU Enlargement and the Euro

“…Thus, the US dollar Infl ation dropped from 84.4% in 1998 and 36.5% in 1999 to 27 15.1% in 2002, and the government budget moved from a large defi cit to a surplus. See also Harrison and Vymyatnina (2007). To some extent, 28 the decline in the use of foreign cash has also been fostered by administrative measures.…”