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The "Exorbitant Privilege": A Theoretical Exposition

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Author Info

  • Wenli Cheng

    (Department of Economics, Monash University)

  • Dingsheng Zhang

    (China Economics and Management Academy, Central University of Finance and Economics)

Abstract

This paper develops a general equilibrium model to study how the "exorbitant advantage" works, whether it is sustainable, and what may be the consequences if it is removed. Its main findings are: (1) the center country that issues the reserve currency enjoys the "exorbitant advantage" in the sense that her current account deficit can be financed by the periphery country¡¯s reserve holdings. The "exorbitant privilege" is predicated on the overvaluation of the reserve currency caused by a higher rate of money growth in the center country; (2) the "exorbitant advantage" is not likely to be sustainable in the long run; (3) if the "exorbitant advantage" is removed, the value of the reserve currency will depreciate, the terms of trade will change against the periphery country and sector composition will change in favour of the tradable sector in the center country and in favour of the non-tradable sector in periphery country. These changes will be more pronounced if the center country repays her debt by printing money instead of raising taxes.

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Bibliographic Info

Paper provided by China Economics and Management Academy, Central University of Finance and Economics in its series CEMA Working Papers with number 435.

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Length: 25 pages
Date of creation: 2011
Date of revision:
Handle: RePEc:cuf:wpaper:435

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Web page: http://cema.cufe.edu.cn/
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Related research

Keywords: "Exorbitant Privilege"; international currency; external imbalances; foreign debt; internal adjustment;

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References

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  1. Kevin X.D. Huang & Thaneepanichskul Suchada, 2003. "Sources of Exchange Rate Fluctuations: The Cases of Mexico and Thailand in the Aftermaths of their Recent Currency Crises," Annals of Economics and Finance, Society for AEF, vol. 4(2), pages 375-400, November.
  2. Lucas, Robert Jr., 1982. "Interest rates and currency prices in a two-country world," Journal of Monetary Economics, Elsevier, vol. 10(3), pages 335-359.
  3. Michael P. Dooley & David Folkerts-Landau & Peter Garber, 2004. "The revived Bretton Woods system," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 9(4), pages 307-313.
  4. Ricardo J. Caballero & Emmanuel Farhi & Pierre-Olivier Gourinchas, 2006. "An Equilibrium Model of Global Imbalances and Low Interest Rates," 2006 Meeting Papers 894, Society for Economic Dynamics.
  5. Guillermo A. Calvo & Carmen M. Reinhart, 2002. "Fear Of Floating," The Quarterly Journal of Economics, MIT Press, vol. 117(2), pages 379-408, May.
  6. Laura Alfaro & Sebnem Kalemli-Ozcan & Vadym Volosovych, 2008. "Why Doesn't Capital Flow from Rich to Poor Countries? An Empirical Investigation," The Review of Economics and Statistics, MIT Press, vol. 90(2), pages 347-368, 01.
  7. Wenli Cheng & Dingsheng Zhang, 2011. "International Transmission of Monetary Shocks and the Non-Neutrality of International Money," CEMA Working Papers 434, China Economics and Management Academy, Central University of Finance and Economics.
  8. Gourinchas, Pierre-Olivier & Rey, Hélène, 2005. "From World Banker to World Venture Capitalist: US External Adjustment and The Exorbitant Privilege," CEPR Discussion Papers 5220, C.E.P.R. Discussion Papers.
  9. Stockman, Alan C. & Dellas, Harris, 1989. "International portfolio nondiversification and exchange rate variability," Journal of International Economics, Elsevier, vol. 26(3-4), pages 271-289, May.
  10. Pierre-Olivier Gourinchas & Helene Rey & Nicolas Govillot, 2010. "Exorbitant Privilege and Exorbitant Duty," IMES Discussion Paper Series 10-E-20, Institute for Monetary and Economic Studies, Bank of Japan.
  11. Michael P. Dooley & David Folkerts-Landau & Peter Garber, 2004. "The Revived Bretton Woods System: The Effects of Periphery Intervention and Reserve Management on Interest Rates & Exchange Rates in Center Countries," NBER Working Papers 10332, National Bureau of Economic Research, Inc.
  12. Reinhart, Carmen & Rogoff, Kenneth, 2009. "This Time It’s Different: Eight Centuries of Financial Folly-Preface," MPRA Paper 17451, University Library of Munich, Germany.
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Blog mentions

As found by EconAcademics.org, the blog aggregator for Economics research:
  1. What if the US looses its reserve currency privilege?
    by Economic Logician in Economic Logic on 2011-08-08 14:16:00
Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
Cited by:
  1. Wilhelm Kohler, 2011. "Zahlungsbilanzkrisen im Eurosystem: Griechenland in der Rolle des Reservewährungslandes?," Ifo Schnelldienst, Ifo Institute for Economic Research at the University of Munich, vol. 64(16), pages 12-19, 09.

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