Dollarization of Deposits in the Short and Long Run: Evidence from CESE Countries

In this paper, we study the drivers of permanent and transitory deposit dollarization for a sample of CESE countries using panel cointegration techniques. The results suggest that a positive cointegration relationship exists between permanent dollarization and Minimum Variance Portfolio (MVP) share. This provides an additional empirical validation of the MVP method as the standard tool for analyzing financial dollarization. In the long run, agents make savings decisions based on the relative volatilities of inflation and nominal depreciation rates and do not take into account the interest rate spread. Somewhat different factors affect dollarization in the short rather than in the long run. Namely, apart from MVP share, transitory deposit dollarization is driven, also, by the real interest rate spread. Our results suggest that affecting dollarization through changes in the interest rate spread may have a short term impact. In the long run, however, for de-dollarization it is critical to reduce the volatility of inflation compared to the volatility of exchange rate depreciation.