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Vehicle currency

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  • Michael B. Devereux
  • Shouyong Shi

Abstract

While in principle, international payments could be carried out using any currency or set of currencies, in practice, the U.S. dollar is predominant in international trade and financial flows. The dollar acts as a "vehicle currency" in the sense that agents in nondollar economies will generally engage in currency trade indirectly using the U.S. dollar rather than using direct bilateral trade among their own currencies. Indirect trade is desirable when there are transactions costs of exchange.> ; This paper constructs a dynamic general equilibrium model of a vehicle currency. We explore the nature of the efficiency gains arising from a vehicle currency, and show how this depends on the total number of currencies in existence, the size of the vehicle currency economy, and the monetary policy followed by the vehicle currency's government. We find that there can be very large welfare gains to a vehicle currency in a system of many independent currencies. But these gains are asymmetry weighted towards the residents of the vehicle currency country. The survival of a vehicle currency places natural limits on the monetary policy of the vehicle country.

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Paper provided by Federal Reserve Bank of Dallas in its series Globalization and Monetary Policy Institute Working Paper with number 10.

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Date of creation: 2008
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Handle: RePEc:fip:feddgw:10

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Keywords: International trade ; Dollar; American ; Equilibrium (Economics) - Mathematical models ; Monetary policy;

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References

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  1. Linda S. Goldberg & Cedric Tille, 2005. "Vehicle currency use in international trade," Staff Reports 200, Federal Reserve Bank of New York.
  2. Allen Head & Shouyong Shi, 2000. "A Fundamental Theory of Exchange Rates and Direct Currency Trades," Working Papers 993, Queen's University, Department of Economics.
  3. Rey, Hélène, 1999. "International Trade and Currency Exchange," CEPR Discussion Papers 2226, C.E.P.R. Discussion Papers.
  4. Huang, Roger D & Stoll, Hans R, 1997. "The Components of the Bid-Ask Spread: A General Approach," Review of Financial Studies, Society for Financial Studies, vol. 10(4), pages 995-1034.
  5. Wright Randall & Trejos Alberto, 2001. "International Currency," The B.E. Journal of Macroeconomics, De Gruyter, vol. 1(1), pages 1-17, April.
  6. Paul R. Krugman, 1979. "Vehicle Currencies And the Structure Of International Exchange," NBER Working Papers 0333, National Bureau of Economic Research, Inc.
  7. Hartmann,Philipp, 1998. "Currency Competition and Foreign Exchange Markets," Cambridge Books, Cambridge University Press, number 9780521632737, April.
  8. Shapley, Lloyd S & Shubik, Martin, 1977. "Trade Using One Commodity as a Means of Payment," Journal of Political Economy, University of Chicago Press, vol. 85(5), pages 937-68, October.
  9. Glassman, Debra, 1987. "Exchange rate risk and transactions costs: Evidence from bid-ask spreads," Journal of International Money and Finance, Elsevier, vol. 6(4), pages 479-490, December.
  10. Aliber, Robert Z. & Chowdhry, Bhagwan & Yan, Shu, 2000. "Transactions Costs in the Foreign Exchange Market," University of California at Los Angeles, Anderson Graduate School of Management qt4qw3p6rp, Anderson Graduate School of Management, UCLA.
  11. Ross M. Starr, 2003. "Why is there money? Endogenous derivation of `money' as the most liquid asset: a class of examples," Economic Theory, Springer, vol. 21(2), pages 455-474, 03.
  12. Peter Howitt, 2005. "Beyond Search: Fiat Money In Organized Exchange," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 46(2), pages 405-429, 05.
  13. Ronald McKinnon & Gunther Schnabl, 2003. "The East Asian Dollar Standard, Fear of Floating, and Original Sin," Working Papers 112003, Hong Kong Institute for Monetary Research.
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Cited by:
  1. Linda Goldberg & Cedric Tille, 2013. "A bargaining theory of trade invoicing and pricing," Globalization and Monetary Policy Institute Working Paper 144, Federal Reserve Bank of Dallas.
  2. Chinn, Menzie David & Frankel, Jeffrey A., 2006. "Will the Euro Eventually Surpass the Dollar As Leading International Reserve Currency?," Santa Cruz Department of Economics, Working Paper Series qt4hz4n9pb, Department of Economics, UC Santa Cruz.
  3. Prakash Kannan, 2007. "On the Welfare Benefits of An International Currency," IMF Working Papers 07/49, International Monetary Fund.
  4. Linda Goldberg & Cedric Tille, 2006. "The internationalization of the dollar and trade balance adjustment," Staff Reports 255, Federal Reserve Bank of New York.
  5. Linda S. Goldberg & Cedric Tille, 2005. "Vehicle Currency Use in International Trade," NBER Working Papers 11127, National Bureau of Economic Research, Inc.
  6. Canzoneri, Matthew & Cumby, Robert & Diba, Behzad & López-Salido, David, 2013. "Key currency status: An exorbitant privilege and an extraordinary risk," Journal of International Money and Finance, Elsevier, vol. 37(C), pages 371-393.
  7. Linda S. Goldberg & Cédric Tille, 2006. "The International Role of the Dollar and Trade Balance Adjustment," NBER Working Papers 12495, National Bureau of Economic Research, Inc.

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