Currency substitution in Turkey

The phenomenon that domestic money looses the essential functions (medium of exchange, store of value and unit of account) against foreign monies slowly is called currency substitution. According to the theory of currency substitution, there are two important factors which cause currency substitution. They are; (1) Expected inflation, and (2) Expected exchange rate depreciation. Economic individuals demand foreign money to prevent depreciation of their savings and/or to get speculative gains by using exchange rate differentials. And, when foreign money demand reaches a level in that foreign money can take over the essential functions of domestic money, it has been met the phenomenon of currency substitution. In this study, it was investigated whether the hypothesis mentioned above are valid for Turkey or not. In short term analysis, by assuming that inflation and depreciation expectations are "rational" or "adaptive", inflation expectation elasticity of foreign money demand was founded out negative and less than one. However, it could not be founded out that a meaningful relationship exist between expected exchange rate depreciation and foreign money demand. Co-integration analysis was used to determine the long-run relationships. Long-run expected inflation elasticity of foreign money demand, like short-run, was founded out negative and less than one. But, long-run depreciation rate elasticity of foreign money demand could not be estimated because of the matter fact that these two time-series are stationary in different levels. vm