Currency depreciation and income inequality in a dollarized economy: the case of Turkey

There has been an on-going debate whether currency depreciation causes dollarization or vice versa. And in a highly dollarized country, like Turkey, depreciation of the domestic currency may increase income inequality. This paper discusses these two related issues by empirically examining the relationship between the depreciation of Turkish Lira and dollarization and then examining the impacts of the depreciation of Turkish Lira and dollarization on GINI coefficient of Turkey between 2001 and 2020. The GARCH analysis suggested that nominal exchange rate movement is the Granger cause of dollarization which is consistent with our hypothesis. And then this paper applied the Auto Regressive Distributed Lag (ARDL) bounds testing approach for the long run relationship and applied Vector Error Correction Model (VECM) for the short run relationship between nominal exchange rate depreciation and GINI coefficient in Turkey. We find that nominal depreciation of Turkish Lira worsens income inequality in Turkey in the short-term and an increase in dollarization aggravates income inequality both in the short and the long term. This study also found that an increase in unemployment decreases income inequality, an increase in economic growth per capita increases income inequality and an increase in inflation decreases income inequality in Turkey. Keywords: Dollarization, Exchange Rate, Depreciation, Income Inequality, Turkey