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Vehicle currency

  • Devereux, Michael B.
  • Shi, Shouyong

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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Length: 44 pages
Date of creation: 2008
Date of revision:
Handle: RePEc:fip:feddgw:10
Note: Published as: Devereux, Michael B. and Shouyong Shi (2013), "Vehicle Currency," International Economic Review 54 (1): 97-133.
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  1. Ronald McKinnon & Gunther Schnabl, 2003. "The East Asian Dollar Standard, Fear of Floating, and Original Sin," Working Papers 03001, Stanford University, Department of Economics.
  2. 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.
  3. 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.
  4. Hartmann,Philipp, 2007. "Currency Competition and Foreign Exchange Markets," Cambridge Books, Cambridge University Press, number 9780521046930, September.
  5. Rey, Hélène, 1999. "International Trade and Currency Exchange," CEPR Discussion Papers 2226, C.E.P.R. Discussion Papers.
  6. Ross M. Starr, 2003. "Why is there money? Endogenous derivation of `money' as the most liquid asset: a class of examples," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 21(2), pages 455-474, 03.
  7. Allen Head & Shouyong Shi, 2002. "A Fundamental Theory of Exchange Rates and Direct Currency Trades," Working Papers shouyong-03-01, University of Toronto, Department of Economics.
  8. Linda S. Goldberg & Cedric Tille, 2005. "Vehicle Currency Use in International Trade," NBER Working Papers 11127, National Bureau of Economic Research, Inc.
  9. 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.
  10. Wright Randall & Trejos Alberto, 2001. "International Currency," The B.E. Journal of Macroeconomics, De Gruyter, vol. 1(1), pages 1-17, April.
  11. Krugman, Paul, 1980. "Vehicle Currencies and the Structure of International Exchange," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 12(3), pages 513-26, August.
  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. 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.
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