Welfare Effects of Currency Substitution in Iran (1959-2013)

  The devaluation of an economy and currency substitution(CS) are monetary dimensions, which are usually is faced by developing countries, including Iran. CS occurs when the domestic currency of a country cannot perform its functions and is substituted by a foreign money will. CS The has different effects on all economic factors, including households, firms, and the government, and has caused crises in developing countries in recent decades. This phenomenon weakens the national (domestic) currency of a country, either formally (with the will of the government) or informally (without the will of the government). Due to high inflation rates especially in recent years, this phenomenon is still increasing and, therefore, it is necessary to consider its effects on welfare. A major measure to evaluate the welfare of a society is private consumption. This study examines the effects of CS on welfare through its effects on private consumption.
Theoretical frame work
This study examines the welfare effects of currency substitution (CS) through the impact of the degree of CS on private consumption. Individuals convert currency into different assets under inflation conditions. There are several reasons why this conversion occurs. Some people attempt to take advantage of these assets, while others want to eliminate brid of the opportunity cost of holding money. Therefore, they are willing to put money in various courses, including bonds, stocks, foreign currency (especially dollars), long-term saving deposits, and real assets such as durable goods, estate, and tenement. In this study, since the goal is examining the welfare effects of CS, and CS is the replacement of domestic currency with foreign currency (dollar), then it is necessary to examine only the impact of this asset from among others. Generally, no information is available for determining the exact amount of dollars in circulation. An approximate method is the estimation of the amount of dollars in circulation using Kamin and Ericsson’s (2003) method. Kamin and Erickson used a new method to estimate the amount of dollars in circulation. They added the maximum inflation rate(indicative devaluation of the domestic currency) to the function of money demand. Then the formula was used to estimate the amount of dollars in circulation, in which the coefficient of the maximum inflation rate is used. Afterwards, the degree of CS is obtained. Finally, the effect of CS on consumption is estimated. Before using time-series variables in the studies, it is necessary to determine whether they are stationary or non-stationary. If the time-series variables are not stationary, there may be a problem known as the false regression. In this study, the generalized Dickey-Fuller (ADF) test was employed to perform a single root test, and Schwartzbisin (SBC) statistics was utilized because the observation volume is less than 100. Here, variables are the co- integration of the first order, that is, they are stationary with the first-order difference. Consequently, to estimate the real liquidity demand for money in Kamin and Ericsson’s method and estimate the effect of the degree of CS on private consumption, the Johansen- Juselius co-integration approach is used. One of the normalized vectors of co integration in terms of significance is acceptable. Results showed that the coefficient of the degree of CS as an independent variable in the consumption function is significant and negative. In fact, CS affects private consumption and the welfare of individuals, that is, the degree of CS reduces private consumption and welfare.
Conclusions and Suggestions
The results demonstrated that CS influences consumption because CS is meaningful in the function of consumption and its sign is negative. In fact, increasing CS reduces private consumption and also decreases welfare. Due to the negative impact of CS on consumption, monetary and financial authorities are obligated to make decisions to manage and reduce the degree of this phenomenon. These decisions may include the following:Real interest rates are negative in Iran for most years. Therefore, controlling the rate of inflation is a way to prevent having a negative real interest rate .
Risk and uncertainty are high in Iran's financial markets. The reduction of risk can help financial markets to become more attractive.
Providing new financial instruments to attract liquidity to the economy like new Islamic financial papers is recommended.
Establishing economic and curbing inflation to prevent the speculation on the real assets of durable goods is suggested.
Preventing the extreme fluctuations of exchange rate is recommended.