A non-linear estimation of money demand and seigniorage in Turkey

Abstract

This thesis utilizes a special form of Cagan-type money demand function which allows for a variable semi-elasticity of inflation, to compute the seigniorage maximizing inflation in Turkey. Seigniorage is maximized assuming that Central Bank is a profit-oriented organization. Empirical results show that allowing for a variable semi-elasticity in the money demand is not an improvement for the money demand specification and there is not a high degree of substitution between money and alternative assets in Turkey. The results are achieved by utilizing a Cagan-type money demand function and defining the opportunity cost of holding money as (it / 1 + 7r), where n is the inflation rate. The type of the money demand function and definition of the opportunity cost of holding money utilized in the computations do not give enough evidence to conclude that there exists substitution between money and alternative assets, whereas the opposite has been proven and shown that there is currency substitution in Turkey (Selçuk (1994); Selçuk (1997); Akçay et al. (1999)). Both the variable semi-elasticity and constant semi-elasticity forms of money demand show evidence that there exists a seigniorage Laffer curve at steady-state. This evidence is also clear from the quantitative implications of a simple dynamic monetary model of money-in-the-utility function which suggests a variable inflation elasticity of money demand and an increasing welfare cost of inflation.