Modeling and Forecasting Currency in Circulation in Ethiopia
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Date
2014-06
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Addis Ababa University
Abstract
In the literature, Currency in circulation is typically estimated either by specifying a currency demand equation based on the theory of transaction and portfolio demand for money or univariate time series models. The first approach works well with low frequency data but faces limitations with high frequency data series. Using monthly and weekly data of currency in circulation form May 2007 to April 2014, the paper proposes an alternative approach in modeling the high frequency data series by using Multivariate time series (structural model and VAR) univariate time series(trend and ARIMA) Model. The four separate models were estimated with monthly, and two separate models with weekly time series, assembling tools for forecasting trend, seasonal patterns and cycles in individual series separately. Trend and seasonal effects were identified by regressing on trend and seasonal dummies while cyclical dynamics were captured by allowing for ARMA effect in the regression disturbances. The monthly and weekly models clearly identify both intra –month and inter-month variation of currency in circulation. The monthly trend model also indentified that Ethiopian New Year has significant positive impact on demand for currency in Ethiopia.
Finally model comparison result showed both monthly VAR, and trend models outperforms the structural and ARIMA models and trend model performs the weekly data wheel at 5% level of significance. In general this methodology may be used in forecasting currency in circulation with careful assessment of month to month and week to week current developments in the economy.
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Financial Policy Analysis, Financial Policy Analysis and Planning, Policy Analysis and Planning