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The (In)stability of the international monetary system without direct default costs

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  • Wang, Rongyu
  • Worrall, Tim

Abstract

This letter considers a repeated version of the International Monetary System model of Farhi and Maggiori (2018) without a direct default cost. The Hegemon issues a safe asset but must respect a no-default condition that trades off the short-term benefit of default against the continuation value of not defaulting. It is optimal for the Hegemon to keep the issuance constant over time. However, the policy of constant issuance may be unstable. In particular, it is unstable if the Hegemon adopts a simple, short-sighted, heuristic rule that bases current issuance on the issuance of the previous period. If, however, the Hegemon uses a heuristic that is based on the demand for risky assets from the rest of the world, then the corresponding equilibrium is stable.

Suggested Citation

  • Wang, Rongyu & Worrall, Tim, 2025. "The (In)stability of the international monetary system without direct default costs," Finance Research Letters, Elsevier, vol. 86(PB).
    • Handle: RePEc:eee:finlet:v:86:y:2025:i:pb:s1544612325016642
    DOI: 10.1016/j.frl.2025.108410
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    References listed on IDEAS

    as
    1. Fernández-Villaverde, Jesús & Sanches, Daniel, 2023. "A model of the gold standard," Journal of Economic Theory, Elsevier, vol. 214(C).
    2. repec:osf:socarx:j8p3m_v1 is not listed on IDEAS
    3. Kehoe, Timothy J & Levine, David K, 2001. "Liquidity Constrained Markets versus Debt Constrained Markets," Econometrica, Econometric Society, vol. 69(3), pages 575-598, May.
    4. Christopher Clayton & Matteo Maggiori & Jesse Schreger, 2025. "The Political Economy of Geoeconomic Power," AEA Papers and Proceedings, American Economic Association, vol. 115, pages 588-592, May.
    5. Emmanuel Farhi & Matteo Maggiori, 2018. "A Model of the International Monetary System," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 133(1), pages 295-355.
    6. Mark Aguiar & Manuel Amador, 2011. "Growth in the Shadow of Expropriation," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 126(2), pages 651-697.
    7. David Laibson, 1997. "Golden Eggs and Hyperbolic Discounting," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 112(2), pages 443-478.
    Full references (including those not matched with items on IDEAS)

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    Keywords

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    JEL classification:

    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
    • F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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