Academic journal article The European Journal of Comparative Economics

The Measurement of Co-Circulation of Currencies and Dollarization in the Republic of Armenia

Academic journal article The European Journal of Comparative Economics

The Measurement of Co-Circulation of Currencies and Dollarization in the Republic of Armenia

Article excerpt


This paper attempts to estimate the actual (de facto) level of dollarization in Armenia. "Co-circulation" involves the regular use of two or more currencies within an economy. The existence of an unknown amount of foreign currency in circulation makes the outcome of domestic monetary policy uncertain. The volume of foreign currency deposits is easily obtained from the official statistics. However, it is very hard to determine the stock of foreign currency in circulation. The effective money supply may be much larger than the domestic money supply and is subject to behavioral responses which are very different than the movements of the presently measured money supply. The purpose of this paper is to assess the level of dollarization, that is, to evaluate the size and/or proportion of foreign currency in the total money stock of Armenia as a highly dollarized country.

JEL Classification: E4, E5, F3, G21, P2, P3

Keywords: dollarization, currency substitution, asset substitution, foreign currency, transition economies. Armenia

(ProQuest Information and Learning: ... denotes formula omitted.)

1. Introduction

After most restrictions on foreign currency holdings were relaxed in the early 90s, foreign currency notes and deposits in Armenia have been increasing rapidly. At present, foreign currency (principally the U.S. dollar) is widely used in the Republic of Armenia as a medium of exchange and as a means of saving in preference to the domestic currency. Residents hold about three quarters of their total deposits in foreign currency. These deposits constitute about half of broad money. Foreign currency in circulation and deposits, therefore, must be regarded as part of the country's money stock.

Dollarization is an important issue in many developing and transition economies. Currency substitution in developing and Eastern European countries is usually one of the consequences of high and variable inflation. High inflation, in turn, leads to dollarization and eventually to currency substitution. However, high inflation is not the only cause of dollarization.

The issue of currency substitution gained high importance in Eastern European and Former Soviet Union (FSU) countries since the early 90s when the command economy broke down and the newly established market economies became open to the outside world. High inflation and economic instability were present in Armenia in the early years of transition. The volume of foreign currency stock, especially U.S. dollars, increased rapidly under these conditions and became a major part of Armenia's money stock. Monetary stabilization in the late 90s did not substantially reduce the level of dollarization as measured by deposits. Thus the causes why businesses and households prefer to maintain their monetary holdings in foreign currency cannot be explained only by inflation. Other factors, such as the openness of the economy, economic uncertainty, lack of confidence in the domestic currency, play an important role in the high level of dollarization. It appears that unofficial dollarization reflects citizens' perceptions of the stability of the domestic monetary regme, the credibility of monetary policies and the perceived stability of the domestic banking system.

Thus dollarization is viewed as a long-term phenomenon in the Armenian economy and its measurement is essential for the country's monetary policy and for increasing the quality of the national statistics.

Co-circulating foreign currency holdings reflect both currency substitution and asset substitution. The two may have different economic consequences, making the implications of unofficial dollarization for macroeconomic decisions more difficult to predict. The greater the extent and variability of dollarization, the weaker is the central bank's knowledge of and control over the effective money supply. Growing unofficial dollarization reduces the ability of the monetary authority to earn seigniorage from its own currency issue. …

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