Black Market Exchange Rate, Currency Substitution and Demand for Money

Abstract

Strict control on foreign exchange and successive devaluation of domestic currency adopted by Algerian government for nearly four decades resulted in black market for foreign currencies, high inflation rates and consequently, lost of confidence in Algarian dinar as a unit of account and store of value. The aforementioned results have given rise to the phenomenon of currency substitution.The aim of this paper is to provide evidence of the existence of currency substitution in Algeria. Using time series data covering the period 1990-2021 and an autoregressive distributive lag (ARDL) model combined with CUSUM and CUSUMQ, the demand for money in Algeria is estimated. Our results point out to the existence of currency substitution when the black market exchange rate is incorporated in the money demand equation. Our findings contribute to the existing litterature on currency substitution issue. As far as policy makers are concerned, the existence of CS could hinder the effectiveness of stabilization policies and thus, means of reducing currency substitution should be devoted.