Currency Substitution in a Transitional Economy with an Application to the Czech Republic

Currency substitution appears to be an important issue affecting the design of monetary policy, especially in transition economies. This article strives to analyze the particular relevance of the currency substitution phenomenon in the Czech Republic. We initially discuss the role of currency substitution in small open economies in transition with some illustrations relating to the Czech Republic. We distinguish and analyze a locally and globally substituting currency from substituted ones and discuss the consequences of euroization. Further, we estimate a modified Branson and Henderson portfolio model for the Czech Republic. This provides a multiperspective approach to currency substitution in the broad sense. We attempt to improve the robustness of our estimations by applying several cointegration techniques, namely, the Johansen procedure, ARDL, DOLS, and ADL. Finally, we discuss the potential implications of currency and asset substitution according to our estimates for the Czech economy.