Forecasting Currency In Circulation Finance Essay

Existing literatures forecasted CIC as it is one of the most important issues act uponing the liquidness of the fiscal market. Given that the Bank of Mauritius ( BOM ) is the exclusive distributer of currency it may non calculate the demand for the currency exactly as it is strongly influenced by the non-banking sector. Therefore this thesis introduces an ARIMA and arrested development theoretical account to calculate CIC in the instance of Mauritius. The BOM did non set about a similar survey earlier ; hence this paper is the first survey that forecasts the CIC in the instance of Mauritius and this survey is critical chiefly for policymakers.

1.1 Aims & A ; Aims

The purpose of this research is to calculate CIC in the instance of Mauritius utilizing ARIMA and arrested development theoretical account on a monthly footing. Furthermore, the other aim is gauging accurate currency demand as this would let the Central Bank to plan pecuniary policy schemes beforehand and to pull off liquidness expeditiously. This would assist the Central Bank to calculate currency demand exactly and therefore taking to an effectual pecuniary policy execution. Last, cointegration analysis is used to analyze the relationship between CIC and Gross Domestic Product ( GDP ) .

1.2 Methodology

To pattern and calculate CIC, the ARIMA and arrested development theoretical accounts are used. The Box-Jenkins ARMA theoretical accounts used in prediction is by and large viewed to be an effectual prediction technique and is used widely, for univariate clip series.

The sample covers the period of January 2000 to December 2011. The existent information for the period of January 2012 to November 2012 have been used to prove the cogency of the prognosis. In Mauritius, the information for CIC are published by the BOM at monthly intervals and the information is available in the monthly statistical bulletin of the Bank of Mauritius.

The cointegration is performed utilizing the Johansen cointegration trial and quarterly clip series informations about GDP for the period 2000-2011 is gathered from the Central Statistics Office ( CSO ) .

1.3 Organization of survey

This piece of work is organised as follows:

Chapter 2: Reappraisal of theoretical and empirical literature

The subdivision explores the different positions brought frontward by assorted research workers on CIC. This chapter is really of import in the sense that the empirical literature provides counsel and relevancy to the survey.

Chapter 3: Overview of the Mauritanian economic system

The chapter provides an overview of Mauritius.

Chapter 4: Research Methodology

In this subdivision, we introduce the methodological analysis that we will utilize for our survey. The information obtained came from dependable beginnings. A clip series analysis is carried out utilizing Mauritanian monthly informations over 2000-2012 to calculate CIC and quarterly clip series informations about GDP and CIC for the period 2000-2011 are used for the cointegration analysis between CIC and GDP.

Chapter 5: Empirical consequences

This chapter interprets the consequences obtained. The coveted end product is obtained which shows that we are able to reproduce the empirical literature with our methodological analysis.

Chapter 6: Drumhead

This chapter provides the decision of the thesis. It will sum up with briefings of the old chapters and chief findings in this survey. Furthermore, it concludes whether or non the aim of the thesis is attained and provides some policy recommendations.

2.0 Introduction

The chief intent of this chapter is to analyze bing literatures on patterning and calculating Currency in Circulation ( CIC ) . An of import map of the Central Bank is to guarantee a smooth and efficient supply of bills and coins to run into public demand, which is dependent on the degree of economic activity, calendar anomalousnesss, and the betterment in the alternate agencies of payment. Furthermore, a cointegration analysis is used to analyze the relationship between CIC and Gross Domestic Product ( GDP ) .

This chapter is structured as follows: subdivision 2.1 trades with theories based on CIC, pecuniary base, significance of CIC, importance of calculating bills and alterations in the entire sum of bills in circulation. The following subdivision involves the calendar consequence. Section 2.3 explains the findings and theoretical accounts used by other research workers for calculating CIC and the relationship between CIC and GDP. Then subdivision 2.4 relates the sum-up of the literature reappraisal.

2.1 Theoretical Literature

2.1.1 Currency in Circulation

The Bank of Mauritius ( BOM ) is the cardinal bank of the state and as the exclusive currency publishing authorization in Mauritius ; BOM is responsible for publishing currency to the fiscal establishments under its supervising when they need it. When fiscal establishments have more currency than is needed, they send it back to the BOM. The BOM is besides responsible to modulate the banking and recognition system so as to guarantee a proper circulation of recognition and a sound fiscal construction. The BOM Act 2004 specifies that “ The primary object of the Bank shall be to keep monetary value stableness and to advance orderly and balanced economic development ” .

The BOM must invent and implement a figure of steps impacting the supply of modesty money, the money supply and the degree of involvement rates in the economic system to carry through its aim of continuing monetary value stableness.

CIC is defined as the entire sum of bills and coins in circulation outside the cardinal bank. The CIC includes all bills in domestic currency that the economic agents that is families, companies and non-residents demand for a peculiar minute for dealing or as a shop of value. The circulation of bills and coins to the non-banking sector is chiefly carried out by commercial Bankss.

2.1.2 Monetary base

The pecuniary base consists of currency outside Bankss plus militias balances ( sedimentations held by Bankss and other depositary establishments in their histories at the Central Bank ) .

Components of Monetary base

Monetary base = Reserve Money + CIC

Central Bank Balance sheet

Assetss

Liabilitiess

Government securities

CIC

Discount loans

Militias

The two liabilities on the balance sheet, CIC and militias, are frequently referred to as the pecuniary liabilities. They are an of import portion of money supply because additions in either of them would take to an addition in the money supply ( everything else being changeless ) . The amount of CIC and modesty is the pecuniary base.

CIC: It refers to the currency that the Central Bank is publishing and the sum of currency in the custodies of the populace ( outside of Bankss ) and it is an of import constituent of the money supply.

Militias: All Bankss have an history with the Central Bank. The modesty consists of sedimentations at the cardinal bank and currency held by commercial Bankss. Militias are assets for the Bankss but liabilities for the Central Bank, because the Bankss can demand bills at any clip and the Central bank is obliged to fulfill its duty. An addition in militias leads to an addition in the degree of sedimentations and hence in the money supply.

The volume of pecuniary base is controlled by the cardinal bank Open Market Operations ( OMO ) . OMO are the chief instrument of pecuniary policy, dwelling of the purchase and sale of Government securities by the cardinal bank. It is the primary determiner of alterations in militias in the banking system. An unfastened market purchase of authorities security will take to an enlargement of militias and sedimentations in the banking system and hence lead to an enlargement of the pecuniary base and the money supply, while an unfastened market sale of authorities security will take to a contraction of militias and sedimentations in the banking system and hence to a diminution in the pecuniary base and the money supply.

In Less Developed Countries ( LDCs ) , cardinal bank will follow an expansionary pecuniary policy and as a consequence an enlargement of the money supply. This will take to a diminution in existent involvement rate to promote adoption by concerns therefore raising investing and hike economic activities in LDCs.

A alteration in the pecuniary base is due to the intercession of Central Bank in the foreign exchange market, that is the Central Bank either buys or sells foreign currency called international modesty. If the Central Bank decides to sell its foreign currency in exchange for domestic currency this has two effects:

It reduces the Central Bank keeping of international militias.

Because its purchase of currency removes it from the custodies of the populace, CIC falls.

Because the pecuniary base is made up of CIC plus militias, this diminution in currency implies that the pecuniary base has fallen. Likewise if a Central Bank decides to sell its domestic currency to buy foreign currency this will ensue in an equal rise in its international militias and the pecuniary base.

2.1.3 Significance of CIC in an economic system

First, the most of import factor act uponing the liquidness of the fiscal market is the sum of bills and coins in circulation. Cabrero et Al. ( 2002 ) stated that when measuring the liquidness demands of the banking system, it is obligatory to take into consideration the expected value of independent liquidness factors that affect the supply of bank militias. These factors are independent because they are beyond the control of the cardinal bank. For illustration, CIC is one of the chief independent factors. It is a liquidness absorbing factor because hard currency backdowns from Bankss will take to a rise in the degree of CIC induce extra refinancing demands of Bankss which have to run into their modesty demands.

Furthermore, the portion of CIC in money supply that is bills in the custodies of the populace is a cardinal constituent of the money supply steps. The classical economic experts explained that alterations in the money supply have no influence on end product ; they argued that the sum of goods and services produced in the economic system should non depend on the sum of bills in circulation but instead on the economic system ‘s productive capacity and that the monetary value degree will alter harmonizing to alterations in the money supply. This is what is referred to as money neutrality ; money is merely a head covering that enables minutess to happen. Therefore, if there is a rise in the sum of CIC in the economic system, there will be more money trailing more goods and services, hence monetary values will increase. On the other manus, if money supply declines, there will be less money trailing those goods and services, ensuing in a autumn in monetary value.

Finally, the ratio of CIC to nominal Gross Domestic Product ( GDP ) , harmonizing to the classical position money can be understood in footings of the measure theory, which links the degree of nominal GDP, represented by PT ( the monetary value degree, P, multiplied by existent GDP, T ) to the merchandise of the money supply, M, and the speed of money V.

MV=PT

M is the money supply which includes currency and bank sedimentations available to the populace.

V is the speed of money. It fundamentally explains how rapidly the money supply is turned over.

P is the monetary value degree.

T is the entire sum of minutess.

So MV=PT means that the entire GDP at the current monetary value degree is equal to the entire money supply multiplied by how frequently it is turned over.

2.1.4 Importance of prediction bills

Given that the Central bank has the sole right to publish currency ; it can non find precisely the entire sum of CIC as that demand is influenced by the non-banking sector. Therefore, Cardinal Bankss should concentrate on calculating bills in circulation because supplying a precise prognosis would enable the cardinal bank to:

Implement effectual pecuniary policy so they can pull off liquidness expeditiously both in footings of absolute size and in footings of instability

To keep monetary value stableness

Hlavacek et Al. ( 2005 ) stated that since the aim of the Central Bank is to keep monetary value stableness, it needs an accurate estimation of money market liquidness. However, the liquidness is influenced by independent factors that are non under full control of the Central Bank. The most important independent factor is CIC, which is hard to mensurate as it is strongly influenced by many seasonal factors. To acquire over the job Central Banks have been utilizing mathematical theoretical accounts of CIC as supportive tools and most of them have used additive ARMA theoretical accounts.

Balli and Elsamadisy ( 2010 ) forecasted CIC because an accurate anticipation of CIC would assist to stabilise the money market in the short tally and it surely helps to diminish instability in money market rates, therefore ensuing in higher economic growing.

Harmonizing to Fischer ( 2004 ) the entire sum of bills and coins is exhaustively controlled by the pecuniary governments, as cardinal Bankss are, in rule, able to make up one’s mind precisely about the sum of currency they put into circulation and cognize the exact sum of staying currency. Furthermore, cardinal Bankss normally accommodate the entire demand for bills irrespective of its beginning. This notwithstanding, cardinal Bankss are non able to follow the manner that currency takes one time put into circulation. Therefore, there is small consecutive statistical information on where the currency circulates, who holds the currency ( occupants or non-residents ) and on the motivations for which the currency is held ( for minutess, stashing or illegal intents ) . Hence for pecuniary policy intents, the sum of currency held for minutess within the domestic currency country is of peculiar involvement and it should be forecasted.

2.1.5 Changes in the entire sum of bills in circulation

An tremendous figure of issues and state of affairss cause a alteration in the entire sum of CIC that are clearly unmanageable. Variations in the entire sum of CIC straight have an impact on the liquidness of the banking sector.

When bills and coins is returned to the cardinal bank the sum of CIC reduces, hence liquidness of the banking sector additions. Likewise, a hard currency backdown that is, the entire sum of CIC rises will take to a lessening in the liquidness of the system. Therefore alterations in the overall sum of CIC straight influence the liquidness of the banking sector.

Variations in bills in circulation are of involvement to policy shapers because an addition in CIC entails a diminution in sedimentations and as a consequence it leads to a diminution in the handiness of loanable financess for investing, which is indispensable for economic growing. Furthermore, a rise in CIC indicates that there in rising prices in the economic system.

With fiscal invention, that is there is an betterment in the alternate agencies of payment, the rate of growing in the series of bills in circulation has fallen. For illustration important alterations in the application of electronic engineering such as the handiness of recognition cards which give entree to the usage of Automatic Teller Machines ( ATMs ) , Electronic Fund Transfer at Point of Sale ( EFTPOS ) and electronic banking services and overdraft installations have reduced the demand of bills.

CIC is a map of involvement rate. Interest rate denotes the chance cost of keeping money, and as a consequence, the higher the involvement rate the lower the degree of CIC. While, the rate of involvement is lower, the degree of CIC rises.

Another facet that determines CIC is the GDP growing, as people ‘s incomes increase in nominal footings, CIC is likely to lift and as income decreases the sum of bills in circulation diminutions.

Furthermore, there are other irregular phenomena that have an impact on the series of CIC. For illustration, harmonizing to Cabrero et Al. ( 2002 ) the sum of bills in circulation rose quickly in late 1999, because of the Y2K computing machine bug which led to a strong addition in demand for bills.

2.2 The Calendar Effect

Calendar effects are anomalousnesss that relate to the calendar such as the altering month length, the consequence of spiritual and public vacations and the twenty-four hours of the hebdomad consequence. For illustration, calendar anomalousnesss have been documented by Balli and Elsamadisy ( 2010 ) and they are characterized as international phenomena.

Calendars exert intense consequence on the cultural, societal and economic behaviour of the people. Almost all states follow the Gregorian calendar to put its on the job yearss and vacations harmonizing to this calendar. The Gregorian calendar is holding 365 or 366 yearss in every twelvemonth. However, vacations do non follow the Gregorian calendar, as they are based on the festivals and spiritual observations of different cultural groups in the state, whose day of the month vary from twelvemonth to twelvemonth. This makes it disputing to pattern high frequence clip series.

The sum of CIC rises merely before the weekend when ATM webs are filled for the weekend to defy all the shopping activity and diminutions after the weekend that is the trading twenty-four hours consequence. It besides declines before the center of the month and increases towards the terminal of the month as a consequence of the payment of incomes. The sum of CIC additions during the summer vacations and towards the terminal of the twelvemonth, largely around Christmas. Public holidays besides have a strong influence on the sum of bills in circulation.

There are 2 different classs of the public vacation consequence in Mauritius during the twelvemonth, one is the fixed public vacations and 2nd one is the spiritual vacations whose day of the months vary from twelvemonth to twelvemonth.

Fixed Holidays

New Year January 1st and 2nd.

Abolition of Slavery Day February 1st

Independence/Republic Day March 12th.

Labor Day May 1st.

All Saints Day November 1st.

Christmas December 25th.

Traveling Vacations

Thaipoosam Cavadee January/February.

Maha shivaratree February.

Chinese Spring Festival January/February.

Ougadi March.

Id-El-Fitr May/June.

Ganesh Chaturthi September.

Divali October/November.

Fixed vacations

Public vacations which are fixed to a specific day of the month and their places in the month do non alter. For illustration during the Christmas shopping season and the payment of one-year fillips there will be an addition in the series of bills in circulation.

Traveling vacations

Festivals which do non purely follow the Gregorian calendar, the day of the months of spiritual festivals change over clip. That is, though the vacation occurs at about the same month each twelvemonth, the exact day of the month alterations. There is higher demand for bills during gay seasons. Therefore, there is an addition in the sum of bills in circulation merely before the public vacations and lessenings after the vacation.

Intra-monthly consequence

Most of the payments ( rewards, wages and pensions ) to persons are paid at the terminal of the month. Consequently banknotes in circulation additions at this clip. As families make their regular payments, the money goes to the corporate sector and flows back to the banking system and so the demand for currency lessenings until wages are paid once more.

2.3 Empirical Literature

This subdivision provides a brief description of relevant empirical surveies of patterning and calculating CIC. The chief findings have been recorded, merged and compared where appropriate to construct a theoretical account and prognosis CIC. Finally, the nexus between CIC and GDP is examined.

2.3.1 Forecasting CIC

CIC is the most of import independent characteristic in the model of liquidness, both in footings of size and instability. Therefore, research workers have tried to develop prediction agencies that will minimise the prognosis mistakes. By betterment in the prediction techniques, some researches have obtained precise appraisals in recent old ages.

For illustration some documents have predicted the CIC based on the theory of dealing, portfolio demand for money and univariate clip series theoretical accounts. Bhattacharya and Joshi ( 2000 ) have predicted the bill in circulation for India with hebdomadal informations sets from 1992-93 to 1999-00. Another survey by Dheerasinghe ( 2006 ) have predicted CIC for Sri- Lanka with monthly, hebdomadal and day-to-day informations sets for the period 2000-2005 and informations for 2006 were used for station cogency trial. All 3 theoretical accounts used to calculate CIC in Sri-Lanka provided close anticipations during the station sample period. These methodological analysiss work good for low frequence informations but faces limitations with high frequence informations series. Hence Bhattacharya and Joshi ( 2000 ) suggests a utility manner of patterning the hebdomadal growing of CIC by including the ‘day of the month ‘ consequence whereas Dheerasinghe ( 2006 ) proposes another attack in patterning the high frequence informations by break uping the tendency, the seasonal and the cyclical constituents.

Balli and Elsamadisy ( 2010 ) forecasted CIC for the State of Qatar utilizing both arrested development theoretical account and Autoregressive Integrated Moving Average ( ARIMA ) theoretical account. To obtain a precise prognosis, they forecasted the CIC utilizing daily, hebdomadal and monthly informations. They besides took into consideration the effects of vacations, weekends and public vacations on currency keeping. Both theoretical accounts provided satisfactory consequences, nevertheless, the ARIMA theoretical account provides better appraisals for short term prognosiss compared to the mistake footings of arrested development theoretical account which is higher. But, for long term prognosiss, both theoretical accounts suffer from larger prognosis mistakes.

Lang et Al. ( 2008 ) forecasted CIC outside Bankss in Croatia utilizing two econometric theoretical accounts for the short term prognosis. In the past prediction were done by the Croatian National Bank ( CNB ) staff with expertness in foretelling bills in circulation outside Bankss. Hence Lang et Al. ( 2008 ) forecasted CIC utilizing both Regression theoretical account and ARIMA theoretical account. In order to obtain precise prognosiss it is required to formalise its hebdomadal, monthly and one-year forms. However, they concluded that both theoretical accounts provided satisfactory prognosiss. But the arrested development theoretical account is better than the ARIMA theoretical account on the intervals up to 5 yearss in front, whereas the ARIMA is better for long-run skylines.

In a recent survey, Guler and Talasli ( 2010 ) model the day-to-day series of bills in Turkey for the period of September 2004 to January 2009. Their chief motivation was to build an econometric theoretical account to foretell day-to-day CIC, as the CIC is the most of import factors act uponing the liquidness of the Turkish banking system. Hence it is cardinal for the Central Bank of the Republic of Turkey ( CBRT ) to bring forth accurate prognosiss of CIC. Since the entire sum of CIC is out of control of the Central Bank. It is required to build an ARIMA theoretical account. They concluded that the prediction public presentation of the ARIMA based attack is better than the adept judgements. However, the theoretical account has to be invariably checked to better the quality of the theoretical account and do accommodation whenever needed.

Hlavacek et Al. ( 2005 ) forecasted the bills in circulation for the Czech Republic utilizing both feed-forward structured nervous web theoretical account and ARIMA theoretical account for the period July 2003 to June 2004. The intent of their survey was to present feed-forward theoretical account to calculate bills and comparison with an ARIMA theoretical account. They obtained satisfactory consequences utilizing the ARIMA attack for long term skyline ( forecasts more than 2 hebdomads in front ) and short term skyline ( for at most 2 hebdomads in front ) , nevertheless, they stated that the feed-forward nervous web theoretical account is a better attack for analysis of clip series of CIC compared to the ARIMA attack.

Cabrero et Al. ( 2002 ) model the day-to-day series of CIC in the model of managing of the European pecuniary system utilizing the ARIMA attack and Structural Time Series attack ( STS ) . So far, the prediction of CIC has been computed by the National Central Banks ( NCBs ) of the Euro system and the quality of NCBs prognosiss has been good up to now. Yet, there are 2 grounds for foretelling CIC in the Euro country straight. First, this anticipation can be used to supplement and better the National prognosiss and in add-on, the debut of Euro bills in 2002 and the free motion of bills within the Euro country may do the NCBs anticipation less reliable. Consequences presented in their survey shows that these 2 attacks are influential and demo a public presentation which is up to the criterions of the current aggregated prognosis attack employed by the Euro system. They concluded that the ARIMA provides satisfactory prognosiss over 5 yearss and above, while the STS attack is best over skylines of 1 to 4 yearss. Therefore the best prediction theoretical account is a combination of the ARIMA and STS theoretical accounts.

2.3.2 CIC and GDP a cointegration analysis

Harmonizing to the Cambridge attack where MV=PT, any addition in M ( Money Supply ) will convey about a proportionate rise in P ( Price degree ) . As a consequence MV=PT means that entire GDP at current monetary value degree is equal to the entire money supply multiplied by how frequently it is turned over. To prove whether this statement is valid through empirical observation, Bednarik ( 2010 ) examined the Czech economic system utilizing graphical analysis and Vector Auto-Regression ( VAR ) theoretical accounts and found that there is so a strong relationship between GDP and money supply. Another survey by Zapodeanu and Cociuba ( 2010 ) analyzed the information of GDP after taking seasonality and of money supply through the Augmented Dickey-Fuller ( ADF ) trial and found that the two variables are non-stationary. They farther applied the Engle-Granger method and show that the two variables have a cointegrating relationship and concluded that the best theoretical account explicating the relationship between money supply and GDP is the DVAR autoregressive the difference theoretical account. A recent analysis conducted by Mohamadpour et Al. ( 2012 ) attempted at unveiling the relationships that exists between GDP and pecuniary policy in Malaysia. Quarterly information from 1991 to 2011 R unveil to be stationary after the first difference. Hence, they applied the cointegration analysis and Vector Error Correction Model ( VECM ) to analyze the nexus between GDP and money supply. Findingss suggested that the VECM analysis specifies that money supply are statistically important and have a long term influence on GDP. Therefore connoting that increasing money supply in Malaysia will hold a positive impact on GDP.

2.4 Decision

This chapter reviews the theoretical and empirical literature of patterning and calculating CIC and it explores the different positions brought frontward by assorted research workers on CIC. Furthermore, the relationship between GDP and CIC are explored. This chapter is really of import in the sense that the empirical literature provides counsel and relevancy to the survey.