Whenever a country is domestic currency cannot fulfill its duties, foreign currency replaces it. Currency substitution is a common phenomenon in developing countries influenced by economic and political factors. One of the most significant economic aspects is exchange r
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Whenever a country is domestic currency cannot fulfill its duties, foreign currency replaces it. Currency substitution is a common phenomenon in developing countries influenced by economic and political factors. One of the most significant economic aspects is exchange rate overshooting. The main objective of the current study is to investigate the relationship between exchange rate overshooting and currency substitution in Iran. Using Kamin-Ericsson (2003) method, we first examine the foreign currency in circulation and the volume of currency substitution in Iran’s economy using annual data from 1961-2021. Then, the self-explanatory Bayesian Vector Autoregression (BVAR) method is used to investigate the impact of exchange rate overshooting on currency substitution. According to the results, exchange rate overshooting and inflation always lead to increased currency substitution in Iran’s economy. On the other hand, economic growth has a negative effect on currency substitution. Additionally, neutralizing the impact of shocks related to exchange rate overshooting, economic development, and inflation requires more than five years; therefore, economic policymakers must consider the factor when managing currency substitution.
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