Money is a fundamental economic element and a vital tool for the economy and its functionality. Money’s functions can be summarized as being a medium of exchange, a unit of account, and a store of value. Among these functions, money serving as a medium of exchange has primary importance. This function is the main pillar of trade, production and other economic components. While its other functions (i.e., unit of account and store of value) are related to preserving wealth, whereas its function as a medium of exchange is a pure money function. Dollarization is simply a matter of money. In dollarization, foreign currencies substitute or replace the functions of local currency. Understanding and measuring dollarization is possible by observing these functions. The more a foreign currency takes over these functions, the more an economy is subject to dollarization.

Dollarization has emerged as a phenomenon for mostly developing countries consisting of South American, Middle Eastern, North African, and Far East Asian countries. In the aftermath of the collapse of the Soviet Union, the transition economies of Eastern Europe also joined these developing countries. Therefore, dollarization records can be collected from numerous countries all over the world. The countries that deal with dollarization have also had to deal with some other macroeconomic issues such as exchange rate fluctuations and their related crises, inflation, unstable economic growth, and unemployment, and Türkiye is one of these countries. Since the beginning of the financial liberalization that took place in the early 1980s, dollarization has become particularly visible in Türkiye. The 2001 financial crisis occurred as a milestone for the Turkish economy after years of economic turbulence, high inflation, and political instability. This crisis helped establish the many essential regulations that would lead the Turkish financial system to successful years later on. However, that the financial system needed to heal was obvious, with some weaknesses still remaining and currently troubling the country’s prosperity. 

Far from being an isolated issue, dollarization has effects on every aspect of economics. Firstly, this issue creates difficulties for money authorities. The more that foreign currencies replace the functions of a local currency, the more difficult implementing effective money policies becomes. Central banks lose control of money when the money supply shifts to a dollarized structure. Secondly, exchange rates are related to dollarization. A high level of dollarization causes a local currency to depreciate, which in turn furthers dollarization. Individuals and firms nationwide see exchange rates as an indicator of economic resilience. Dollarization and exchange rate fluctuations that oscillate together indicate a confidence issue. Thirdly, dollarization in many cases becomes related to inflation. In open economies, general price levels are directly tied to exchange rate fluctuations due to foreign trade. The link between exchange rate and inflation indicates the importance of dollarization regarding general price levels. 

Dollarization in Türkiye has attracted academic studies that have mainly focused on the factors causing dollarization and the consequences of a dollarized economy. These studies have stated the primary factors causing dollarization to be inflation, nominal and real exchange rates, and local currency depreciation. Studies have additionally stated consumer sentiment index, current account deficit, credit default swap (CDS) premium, and deposit interest rates as other causing factors, with the primary consequences being inflation, exchange rate instabilities, and further dollarization. While the consequences seem to be macroeconomic indicators, the main threat is how it weakens money policy tools. The solution to this risk involves money authorities taking rapid and decisive actions. 

This study examines the nexus between dollarization and the real exchange rate in Türkiye, as these chosen factors reflect a historical reality. Dollarization in Türkiye has had a long record of accompanying the various economic crises, with volatile exchange rates and dollarization having played significant roles in every crisis. Furthermore, the real exchange rate is another significant element, because it is a combined reflection of inflation and exchange rate fluctuations. The study is based on data between January 2003-December 2023 and conducts the Fourier term unit root and cointegration tests. The findings of these tests are then used in the Granger causality test, with the results showing that the interaction between dollarization and real exchange rate works in one direction: Dollarization causes the real exchange rate, while the real exchange rate does not cause dollarization.

According to the results of the study and the nature of dollarization, policy makers should firmly keep their eyes on the dollarization issue, as it causes long-term macroeconomic weaknesses. Dollarization on its own also causes further dollarization. Money policies become less effective over time through dollarization. Controlling inflation also becomes less likely with ineffective policy tools. In conclusion, money authorities should take the dollarization trend under control quickly and early using every tool possible. With the help of a speedy intervention, dollarization will hopefully be prevented from deepening before it causes any more harm on the economy, and this approach will be for the benefit of each actor in the economy