Exchange Overshooting and Currency Substitution in Iran

Abounoori, Esmaiel; Saadat, Rahman; Heshmati Sanzighi, Seyed Mansour

doi:10.48308/jep.2024.236314.1176

Exchange Overshooting and Currency Substitution in Iran

Articles in Press

Document Type : Original Article

Authors

¹ Professor of Econometrics & Social Statistics, Department of Economics, Semnan University, Semnan, Iran .

² Associate Professor of Economics Department of Economics, Semnan University, Semnan-Iran

³ PhD Student of Economics, Department of Economics, Semnan University, Semnan-Iran

10.48308/jep.2024.236314.1176

Abstract

If a country's domestic currency fails to perform its functions, foreign currency substitution occurs. This phenomenon is common in developing countries and is influenced by various economic and political factors. The main objective of this research is to estimate the relationship between exchange rate overshooting and currency substitution in Iran. We first use the Kamin & Ericsson method (2003) to evaluate the amount of circulating foreign currency and currency substitution within the Iranian economy, using annual data from 1979 to 2020. Then, we apply the ARDL method to estimate the impact of exchange rate overshooting on currency substitution. The long-term results indicate that exchange rate overshooting consistently increases currency substitution in Iran. Conversely, gross domestic product negatively affects currency substitution, while war and sanctions moderate this effect. Furthermore, the impact of war is greater than that of sanctions. According to the error correction coefficient (-0.92), it takes about 13 months to reach long-term equilibrium. Understanding the relationship between currency substitution and overshooting helps policymakers design better strategies for managing exchange rates and monetary policy.

Keywords