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An Information-Based Theory of International Currency

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  • Zhang, Cathy

Abstract

This paper develops an information-based theory of international currency based on search frictions, private trading histories, and imperfect recognizability of assets. Using an open-economy search model with multiple competing currencies, the value of each currency is determined without requiring agents to use a particular currency to purchase a country's goods. Strategic complementarities in portfolio choices and information acquisition decisions generate multiple equilibria with different types of payment arrangements. While some inflation can benefit the country issuing an international currency, the threat of losing international status puts an inflation discipline on the issuing country. When monetary authorities interact in a simple policy game, the temptation to inflate can lead optimal policy to deviate from the Friedman rule. A calibration of the generalized model shows that for the U.S. dollar, the welfare cost of losing international status ranges from 1.3% to 2.1% of GDP per year.

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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 42114.

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Date of creation: 18 Oct 2013
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Handle: RePEc:pra:mprapa:42114

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Keywords: international currencies; monetary search; liquidity; information frictions;

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