The demand for money in Turkey and currency substitution

Abstract

Over the last three decades, the Turkish economy has experienced severe macro-shocks, among which depreciation of the Turkish lira is the most noticeable one. The Turkish lira (TL) has depreciated from 13 TL per US dollar in 1973 to more than 1.5 million TL per dollar today. It is expected that because of these shocks, some of the macro-relationships could suffer from structural instability which makes policy formulation and predictions difficult. This paper considers the demand for money in Turkey. To take account of currency substitution, the demand for money that includes the exchange rate in addition to income, interest rate and inflation rate is estimated. After incorporating the CUSUM and CUSUMSQ tests in bounds testing approach for cointegration, it is shown that in Turkey for a successful and effective monetary policy, the monetary authorities would rather concentrate on M1 because not only is it cointegrated with its determinants and it is stable, all four determinants belong to the cointegrating space.

Notes

¹ McNown and Wallace (1992).

² For more details on financial liberalization see Ozatay and Guven (2002).

³ The study period was 1949:3–1987:4.

⁴ Ozatay (1997).

⁵ Some other studies that considered the experiences of other countries are: Hafer and Jansen (1991), Hoffman and Rasche (1991), McNown and Wallace (1992) for the USA; Adams (1991), Johansen (1992) for the UK; Frenkel and Taylor (1993) for Yugoslavia; Bahmani-Oskooee and Shabsigh (1996) for Japan and Bahmani-Oskooee (1996) for Iran.

⁶ Mundel (1963) was the first to recognize the exchange rate as another determinant of the demand for money. McKinnon et al. (1984) and McNown and Wallace (1992) who considered the money demand in the United States also recognized this fact and included the exchange rate of the dollar in their formulation.