The loss of interest for the euro in Romania
📝 Abstract
We generalize a money demand micro-founded model to explain Romanians’ recent loss of interest for the euro. We show that the reason behind this loss of interest is a severe decline in the relative degree of the euro liquidity against that of the Romanian leu.
💡 Analysis
We generalize a money demand micro-founded model to explain Romanians’ recent loss of interest for the euro. We show that the reason behind this loss of interest is a severe decline in the relative degree of the euro liquidity against that of the Romanian leu.
📄 Content
1
The loss of interest for the euro in Romania
Claudiu Tiberiu ALBULESCU1 and Dominique PÉPIN2 1 Management Department, Politehnica University of Timisoara 2 CRIEF, University of Poitiers
Abstract We generalize a money demand micro-founded model to explain Romanians’ recent loss of interest for the euro. We show that the reason behind this loss of interest is a severe decline in the relative degree of the euro liquidity against that of the Romanian leu.
Keywords: money demand, open economy model, currency substitution, Romania JEL codes: E41, E52, F41
Corresponding author. E-mail addresses: claudiu.albulescu@upt.ro, claudiual@yahoo.com. 2
- Introduction
Romania joined the European Union (EU) in 2007 being now one of the Euro area candidate
countries. Long before Romania’s entrance to the EU, the leu and the euro went hand in hand
as the main transactions and savings currencies. However, since September 2001, the euro
holding has considerably diminished as compared to that of the domestic currency.
Let t M denote the Romanian domestic money holding, while
t
M is the euro holding.
Assuming that
tS is the exchange rate, then
*
t
tM
S
represents the euro holding denominated in
lei. Figure 1 shows the drop of the
*
t
tM
S
/
t
M ratio over the period 2001:M9-2015:M11.
Figure 1. Romanians’ euro holding to domestic money holding ratio
0.4
0.5
0.6
0.7
0.8
0.9
1.0
1.1
1.2
01
02
03
04
05
06
07
08
09
10
11
12
13
14
15
Source: Own computations based on monthly bulletins of the National Bank of Romania
The literature on money demand provides no explanation for such a trend. The money
demand in the CEE countries is empirically investigated by Van Aarle and Budina (1996),
Mulligan and Nijsse (2001), Dreger et al. (2007), Fidrmuc (2009), or Dritsaki and Dritsaki
(2012). Single-country analyses of money demand are conducted inter-alia by Komárek and
Melecký (2004) for the Czech Republic, by Siliverstovs (2008) for Latvia, or by Hsieh and
Hsing (2009) for Hungary. The money demand in Romania was investigated by Andronescu
et al. (2004) and Ruxanda and Muraru (2011). None of these papers provides a micro-founded
theoretical model to justify the specification of their empirical money demand functions.
Albulescu and Pépin (2016) represent an exception.
Our contribution to the existing literature is twofold. First, we generalize the micro-founded
model of Albulescu and Pépin (2016) by assuming that the relative liquidity degree of the
3
euro against that of the leu is changing. Second, we apply the new model on the Romanian
case and explain the loss of interest for the euro during the last period.
2. A money demand model in an open economy
Generalizing Albulescu and Pépin (2016), we suppose that the lifetime utility function of the
domestic agent is:
i
t,
;
P
M
S
,
P
M
,
P
X
U
E
V
i
t
i
t
*
i
t
i
t
i
t
i
t
i
t
i
t
0
i
i
t
t
,
(1)
where
t
X is the monetary consumption spending denominated in lei,
tP is the price index,
t
is a stationary stochastic process and t is a deterministic trend.
.
Et
is the expectation
conditional upon the information available at time t and the presence of
t and of trend t in
the utility function indicates that its properties are subject to changes. This utility specification
is based on the assumption that the representative agent holds foreign and domestic money in
relation with his total consumption, with no distinction between his consumption of foreign
and domestic goods.
Now suppose that the utility function takes the form:
t
*
t
t
t
t
t
t
1
t
t
t
t
t
t
t
t
t
t
P
M
S
,t
1
P
M
,t
P
X
,t;
P
M
S
,
P
M
,
P
X
U
,
1 ,
(2)
where
)
1
/(
1
is the elasticity of substitution between the leu and the euro and
t
,t
is
a function of t and
t (the share parameter).
If the elasticity is high, it is easier to replace one currency by another, which represents a
proof of monetary integration (Fidrmuc, 2009). Therefore, if
1
we have substitutability
between currencies, while a value
1
indicates their complementarity. In their simplified
model, where
t
,t
t
, Albulescu and Pépin (2016) find that the elasticity of
substitution between the leu and the euro is weak, ranging between 0.3 and 0.5 under different
estimations, and reject thus the hypothesis of monetary integration with the Euro area.
The expression
1
t
*
t
t
t
t
t
t
P
M
S
,t
1
P
M
,t
is the liquidity production function
and the term
t
t
,t
/
,t
1
measures the liquidity degree of the euro against the leu in
the eyes of the Romanian repr
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