Portfolio models of financial intermediation2 suggest that the combination of inflation targeting and increased exchange rate volatility should foster the use of the local currency and discourage the use of the foreign currency. Preliminary econometric analysis of the Serbian data for the past three-years suggests that indeed there exists a relatively fast link between higher exchange rate volatility and a higher degree of dinarisation.
In particular, higher monthly exchange rate volatility appears to increase the loan dinarisation with a delay of around two months. Also, increased exchange rate flexibility might be contributing to the somewhat weakening link between domestic prices and the exchange rate.