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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 US dollar is predominant in international trade and financial flows. The dollar acts as a `vehicle currency' in the sense that agents in non-dollar economies will generally engage in currency trade indirectly using the US 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 asymmetrically 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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Bibliographic Info

Paper provided by University of Toronto, Department of Economics in its series Working Papers with number tecipa-315.

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Length: 45 pages
Date of creation: 25 Apr 2008
Date of revision:
Handle: RePEc:tor:tecipa:tecipa-315

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Keywords: Vehicle currency; Transactions cost; Welfare gains;

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References

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  1. Wright Randall & Trejos Alberto, 2001. "International Currency," The B.E. Journal of Macroeconomics, De Gruyter, De Gruyter, vol. 1(1), pages 1-17, April.
  2. Glassman, Debra, 1987. "Exchange rate risk and transactions costs: Evidence from bid-ask spreads," Journal of International Money and Finance, Elsevier, Elsevier, vol. 6(4), pages 479-490, December.
  3. Rey, Hélène, 1999. "International Trade and Currency Exchange," CEPR Discussion Papers, C.E.P.R. Discussion Papers 2226, C.E.P.R. Discussion Papers.
  4. Shapley, Lloyd S & Shubik, Martin, 1977. "Trade Using One Commodity as a Means of Payment," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 85(5), pages 937-68, October.
  5. 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, Anderson Graduate School of Management, UCLA qt4qw3p6rp, Anderson Graduate School of Management, UCLA.
  6. Hartmann,Philipp, 2007. "Currency Competition and Foreign Exchange Markets," Cambridge Books, Cambridge University Press, Cambridge University Press, number 9780521046930.
  7. Linda S. Goldberg & Cedric Tille, 2005. "Vehicle currency use in international trade," Staff Reports, Federal Reserve Bank of New York 200, Federal Reserve Bank of New York.
  8. Allen Head & Shouyong Shi, 2000. "A Fundamental Theory of Exchange Rates and Direct Currency Trades," Working Papers, Queen's University, Department of Economics 993, Queen's University, Department of Economics.
  9. Ronald McKinnon & Gunther Schnabl, 2003. "The East Asian Dollar Standard, Fear of Floating, and Original Sin," Working Papers, Hong Kong Institute for Monetary Research 112003, Hong Kong Institute for Monetary Research.
  10. Paul R. Krugman, 1979. "Vehicle Currencies And the Structure Of International Exchange," NBER Working Papers 0333, National Bureau of Economic Research, Inc.
  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, 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, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 46(2), pages 405-429, 05.
  13. 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, Society for Financial Studies, vol. 10(4), pages 995-1034.
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Cited by:
  1. Goldberg, Linda S. & Tille, Cédric, 2013. "A bargaining theory of trade invoicing and pricing," CEPR Discussion Papers, C.E.P.R. Discussion Papers 9447, C.E.P.R. Discussion Papers.
  2. Linda Goldberg & Cedric Tille, 2006. "The internationalization of the dollar and trade balance adjustment," Staff Reports, Federal Reserve Bank of New York 255, Federal Reserve Bank of New York.
  3. Prakash Kannan, 2007. "On The Welfare Benefits Of An International Currency," 2007 Meeting Papers, Society for Economic Dynamics 29, Society for Economic Dynamics.
  4. Chinn, Menzie David & Frankel, Jeffrey A., 2005. "Will the Euro Eventually Surpass the Dollar as Leading International Reserve Currency?," Center for Global, International and Regional Studies, Working Paper Series, Center for Global, International and Regional Studies, UC Santa Cruz qt6p4215w1, Center for Global, International and Regional Studies, UC Santa Cruz.
  5. 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.
  6. Pietro Cova & Patrizio Pagano & Massimiliano Pisani, 2014. "Foreign exchange reserve diversification and the "exorbitant privilege"," Temi di discussione (Economic working papers), Bank of Italy, Economic Research and International Relations Area 964, Bank of Italy, Economic Research and International Relations Area.
  7. Goldberg, Linda S. & Tille, Cédric, 2008. "Vehicle currency use in international trade," Journal of International Economics, Elsevier, Elsevier, vol. 76(2), pages 177-192, December.
  8. 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, Elsevier, vol. 37(C), pages 371-393.

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