The Currency Ration in Relation to Economic Development

Abstract

The money supply process can generally be attributed to the behavior of three agents: the behavior of the non-bank public as represented by the variations in the currency ratio and defined as the currency held by the non-bank public as a fraction of some measure of money supply; variations in the required and excess reserves held by the commercial banks (known as the reserve ratio); and the central bank, whose behavior is reflected in variations of the monetary base. Debate has long surrounded this concept, in particular regarding the question of whether the monetary base is under the total control of the central bank. Thus, this question sparks the two main objectives of this study. First, this study sought to investigate whether a long-term decline in the currency ratio for six Middle Eastern countries {Israel, Turkey, Iran, Jordan, Syria, and Egypt) would occur during the process of economic development of a country. Second, this study examined the degree to which the three money supply components influenced the growth rate of M2 during the period 1970 to 2001. Results of interest were found concerning each hypothesis. For the first hypothesis, currency as a ratio ofM1 (c1) declined over the period 1970-2001 for Iran, but not for any of the other countries, while currency as a ratio of M2 (c2) in Iran, Egypt, and Jordan showed the type of decrease expected with some degree of economic and financial development. For the second hypothesis, in Iran and Israel the impact of the multiplier fluctuations, resulting mostly from reserve ratio fluctuations, must have seriously complicated the job of the central bank. In Syria, both the reserve ratio and the currency ratio were not very volatile, and thus relative stability in the money supply growth was maintained. The opposite of Syria occurred in Turkey, which experienced significant fluctuations in the multiplier. In Jordan, the impact of the fluctuations in the currency ratio during the 1970's, then the reserve ratio in the 1980's and 1990's, must have complicated the job of the central bank in controlling money supply. Finally, in Egypt, the two components of the money multiplier fluctuated significantly in the 1970's and the 1980's, but stabilized in the 1990's allowing the monetary authorities to posses a greater ability to maintain relatively stable levels of money supply growth.