SUMMARY : This study is undertaken with an objective of finding whether the currency ^ substitution started and accelerated after the financial liberalization policies began to be applied in Turkey. The study attempts to see the effects of the factors which are expected to influence the currency substitution. The study covers the period 1985 - 1994. The currency substitution is defined as the ratio of M2A definition of money (which does not contain foreign exchange deposits ) over foreign exchange deposits. We have tried to find out the change in domestic money and foreign currency as the explanatory variables change. As independent variables, dollar exchange rates, quarterly interest rates, inflation rate and industrial production index as a proxi for income have been used. Vector Autoregressive estimation (VAR) is applied to the data to see the interaction among the variables. However, before the implementation of this method, stationary tests are made and Perron tests are used to eliminate the stationarity of variables. After making cointegration analysis, through Johansen Estimation, the interrelation among variables is observed. Since the trend stationary variables have time breaks around late 1988 and early 1989, the estimation has been also done for the period 1988Q4 - 1994Q4. The empirical estimation shows that, the currency substitution started to be observed more profoundly after the financial liberalization policies began to be applied. Interest rates have become a frequently applied tool to eliminate the currency substitution, besides the function of financing the public deficit through debt financing.

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