IDEAS home Printed from https://ideas.repec.org/
MyIDEAS: Log in (now much improved!) to save this paper

An Information-Based Theory of International Currency

  • Zhang, Cathy

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.

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.

File URL: https://mpra.ub.uni-muenchen.de/42114/1/MPRA_paper_42114.pdf
File Function: original version
Download Restriction: no

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

as
in new window

Length:
Date of creation: 18 Oct 2013
Date of revision:
Handle: RePEc:pra:mprapa:42114
Contact details of provider: Postal:
Ludwigstraße 33, D-80539 Munich, Germany

Phone: +49-(0)89-2180-2459
Fax: +49-(0)89-2180-992459
Web page: https://mpra.ub.uni-muenchen.de

More information through EDIRC

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

as in new window
  1. Marc Flandreau & Clemens Jobst, 2009. "The Empirics of International Currencies: Network Externalities, History and Persistence," Economic Journal, Royal Economic Society, vol. 119(537), pages 643-664, 04.
  2. Scott Freeman & Finn E. Kydland, 1998. "Monetary aggregates and output," Working Papers 1998-013, Federal Reserve Bank of St. Louis.
  3. Papaioannou, Elias & Portes, Richard & Siourounis, Gregorios, 2006. "Optimal currency shares in international reserves: the impact of the euro and the prospects for the dollar," Working Paper Series 0694, European Central Bank.
  4. Cavalcanti, Ricardo de O & Wallace, Neil, 1999. "Inside and Outside Money as Alternative Media of Exchange," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 31(3), pages 443-57, August.
  5. Stephen D. Williamson & Randall Wright, 1991. "Barter and monetary exchange under private information," Staff Report 141, Federal Reserve Bank of Minneapolis.
  6. Andrew W. Lo & Harry Mamaysky & Jiang Wang, 2004. "Asset Prices and Trading Volume under Fixed Transactions Costs," Journal of Political Economy, University of Chicago Press, vol. 112(5), pages 1054-1090, October.
  7. Devereux, Michael B. & Shi, Shouyong, 2008. "Vehicle currency," Globalization and Monetary Policy Institute Working Paper 10, Federal Reserve Bank of Dallas.
    • Michael B. Devereux & Shouyong Shi, 2013. "Vehicle Currency," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 54(1), pages 97-133, 02.
  8. Linda S. Goldberg & Cedric Tille, 2005. "Vehicle Currency Use in International Trade," NBER Working Papers 11127, National Bureau of Economic Research, Inc.
  9. Aleksander Berentsen & Guillaume Rocheteau & Shouyong Shi, 2002. "Friedman Meets Hosios: Efficiency in Search Models of Money," Working Papers shouyong-02-04, University of Toronto, Department of Economics.
  10. Carmen M. Reinhart & Kenneth S. Rogoff & Miguel A. Savastano, 2003. "Addicted to Dollars," CEMA Working Papers 594, China Economics and Management Academy, Central University of Finance and Economics.
  11. Yohei Okawa & Eric van Wincoop, 2010. "Gravity in International Finance," Working Papers 072010, Hong Kong Institute for Monetary Research.
  12. Nosal, Ed & Rocheteau, Guillaume, 2011. "Money, Payments, and Liquidity," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262016281, March.
  13. Rocheteau, Guillaume, 2011. "Payments and liquidity under adverse selection," Journal of Monetary Economics, Elsevier, vol. 58(3), pages 191-205.
  14. S. Rao Aiyagari & Neil Wallace, 1995. "Government transaction policy, the medium of exchange, and welfare," Working Papers 516, Federal Reserve Bank of Minneapolis.
  15. Chang, Roberto, 1989. "Endogenous Currency Substitution, Inflationary Finance, And Welfare," Working Papers 89-12, C.V. Starr Center for Applied Economics, New York University.
  16. Linda S. Goldberg, 2011. "The international role of the dollar: Does it matter if this changes?," Staff Reports 522, Federal Reserve Bank of New York.
  17. Brunner, Karl & Meltzer, Allan H, 1971. "The Uses of Money: Money in the Theory of an Exchange Economy," American Economic Review, American Economic Association, vol. 61(5), pages 784-805, December.
  18. Ricardo Lagos & Randall Wright, 2004. "A unified framework for monetary theory and policy analysis," Staff Report 346, Federal Reserve Bank of Minneapolis.
  19. Barry Eichengreen & Marc Flandreau, 2012. "The Federal Reserve, the Bank of England, and the Rise of the Dollar as an International Currency, 1914–1939," Open Economies Review, Springer, vol. 23(1), pages 57-87, February.
  20. Michael Devereux & Charles Engel, 2000. "Monetary Policy in the Open Economy Revisited: Price Setting and Exchange Rate Flexibiity," Working Papers 0016, University of Washington, Department of Economics.
  21. Yiting Li & Guillaume Rocheteau & Pierre-Olivier Weill, 2011. "Liquidity and the threat of fraudulent assets," Working Paper 1124, Federal Reserve Bank of Cleveland.
  22. Guillaume Rocheteau, 2008. "Money and competing assets under private information," 2008 Meeting Papers 525, Society for Economic Dynamics.
  23. Ben R. Craig & Christopher J. Waller, 2000. "Dual-currency economies as multiple-payment systems," Economic Review, Federal Reserve Bank of Cleveland, issue Q I, pages 2-13.
  24. Shouyong Shi, 1997. "A Divisible Search Model of Fiat Money," Econometrica, Econometric Society, vol. 65(1), pages 75-102, January.
  25. Ricardo Lagos & Guillaume Rocheteau, 2009. "Liquidity in Asset Markets With Search Frictions," Econometrica, Econometric Society, vol. 77(2), pages 403-426, 03.
  26. Tai-wei Hu & John Kennan & Neil Wallace, 2009. "Coalition-Proof Trade and the Friedman Rule in the Lagos-Wright Model," Journal of Political Economy, University of Chicago Press, vol. 117(1), pages 116-137, 02.
  27. Christopher J. Waller & Elisabeth S. Curtis, 2003. "Currency restrictions, government transaction policies and currency exchange," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 21(1), pages 19-42, 01.
  28. Antoine Martin, 2002. "Endogenous multiple currencies," Research Working Paper RWP 02-03, Federal Reserve Bank of Kansas City.
  29. Bacchetta, Philippe & Van Wincoop, Eric, 2002. "A theory of the currency denomination of international trade," Working Paper Series 0177, European Central Bank.
  30. Craig, Ben & Waller, C.J.Christopher J., 2004. "Dollarization and currency exchange," Journal of Monetary Economics, Elsevier, vol. 51(4), pages 671-689, May.
  31. Goodhart, Charles A. E., 1998. "The two concepts of money: implications for the analysis of optimal currency areas," European Journal of Political Economy, Elsevier, vol. 14(3), pages 407-432, August.
  32. Li, Yiting & Matsui, Akihiko, 2009. "A theory of international currency: Competition and discipline," Journal of the Japanese and International Economies, Elsevier, vol. 23(4), pages 407-426, December.
  33. Qing Liu & Shouyong Shi, 2006. "Currency Areas and Monetary Coordination," Working Papers tecipa-226, University of Toronto, Department of Economics.
  34. Li, Yiting & Wright, Randall, 1998. "Government Transaction Policy, Media of Exchange, and Prices," Journal of Economic Theory, Elsevier, vol. 81(2), pages 290-313, August.
  35. Kiminori Matsuyama, 1991. "Toward a Theory of International Currency," Discussion Papers 931, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  36. Obstfeld, Maurice & Rogoff, Kenneth, 1999. "New Directions for Stochastic Open Economy Models," Center for International and Development Economics Research, Working Paper Series qt5pf7g8sh, Center for International and Development Economics Research, Institute for Business and Economic Research, UC Berkeley.
  37. Alchian, Armen A, 1977. "Why Money?," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 9(1), pages 133-40, February.
  38. Stephanie Schmitt‐Grohé & Martín Uribe, 2012. "Foreign Demand for Domestic Currency and the Optimal Rate of Inflation," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 44(6), pages 1207-1224, 09.
  39. Martin Uribe, 1995. "Hysteresis in a simple model of currency substitution," International Finance Discussion Papers 509, Board of Governors of the Federal Reserve System (U.S.).
  40. Rey, Hélène, 1999. "International Trade and Currency Exchange," CEPR Discussion Papers 2226, C.E.P.R. Discussion Papers.
  41. Friberg, Richard & Wilander, Fredrik, 2008. "The currency denomination of exports -- A questionnaire study," Journal of International Economics, Elsevier, vol. 75(1), pages 54-69, May.
  42. Lyons, Richard K. & Moore, Michael J., 2009. "An information approach to international currencies," Journal of International Economics, Elsevier, vol. 79(2), pages 211-221, November.
  43. Ben Craig & Guillaume Rocheteau, 2006. "Inflation and welfare: a search approach," Policy Discussion Papers, Federal Reserve Bank of Cleveland, issue Jan.
  44. Hartmann,Philipp, 2007. "Currency Competition and Foreign Exchange Markets," Cambridge Books, Cambridge University Press, number 9780521046930, Junio.
  45. Menger, Carl, 1892. "On the Origins of Money," History of Economic Thought Articles, McMaster University Archive for the History of Economic Thought, vol. 2, pages 239-255.
  46. Giancarlo Corsetti & Paolo Pesenti, 2001. "International Dimensions of Optimal Monetary Policy," NBER Working Papers 8230, National Bureau of Economic Research, Inc.
  47. World Bank, 2011. "Global Development Horizons 2011 : Multipolarity - The New Global Economy," World Bank Publications, The World Bank, number 2313, November.
  48. Aleksander Berentsen & Guillaume Rocheteau, . "Money and Information," IEW - Working Papers 099, Institute for Empirical Research in Economics - University of Zurich.
  49. Ehud Kalai, 1977. "Proportional Solutions to Bargaining Situations: Interpersonal Utility Comparisons," Discussion Papers 179, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  50. Camera, Gabriele & Craig, Ben & Waller, Christopher J., 2004. "Currency competition in a fundamental model of money," Journal of International Economics, Elsevier, vol. 64(2), pages 521-544, December.
  51. Prakash Kannan, 2007. "On The Welfare Benefits Of An International Currency," 2007 Meeting Papers 29, Society for Economic Dynamics.
  52. Gomis-Porqueras, Pere & Kam, Timothy & Lee, Junsang, 2010. "Search-Theoretic Money, Capital and International Exchange Rate Fluctuations," PIE/CIS Discussion Paper 477, Center for Intergenerational Studies, Institute of Economic Research, Hitotsubashi University.
  53. Head, Allen & Shi, Shouyong, 2003. "A fundamental theory of exchange rates and direct currency trades," Journal of Monetary Economics, Elsevier, vol. 50(7), pages 1555-1591, October.
  54. Yiting Li & Guillaume Rocheteau, 2008. "On the threat of counterfeiting," Working Paper 0809, Federal Reserve Bank of Cleveland.
  55. Nash, John, 1950. "The Bargaining Problem," Econometrica, Econometric Society, vol. 18(2), pages 155-162, April.
  56. James A. Dorn, 2012. "Editor's Note," Cato Journal, Cato Journal, Cato Institute, vol. 32(2), Spring/Su.
  57. Richard D. Porter & Ruth Judson, 1996. "The location of U.S. currency: how much is abroad?," Federal Reserve Bulletin, Board of Governors of the Federal Reserve System (U.S.), issue Oct, pages 883-903.
  58. Soller Curtis, Elisabeth & Waller, Christopher J., 2000. "A search-theoretic model of legal and illegal currency," Journal of Monetary Economics, Elsevier, vol. 45(1), pages 155-184, February.
  59. King, Robert G. & Wallace, Neil & Weber, Warren E., 1992. "Nonfundamental uncertainty and exchange rates," Journal of International Economics, Elsevier, vol. 32(1-2), pages 83-108, February.
  60. Michael B. Devereux & Charles Engel, 2001. "Endogenous Currency of Price Setting in a Dynamic Open Economy Model," NBER Working Papers 8559, National Bureau of Economic Research, Inc.
  61. Alberto Trejos & Randall Wright, 1996. "Search-theoretic models of international currency," Review, Federal Reserve Bank of St. Louis, issue May, pages 117-132.
  62. Pablo E. Guidotti & Carlos A. Rodriguez, 1992. "Dollarization in Latin America: Gresham's Law in Reverse?," IMF Staff Papers, Palgrave Macmillan, vol. 39(3), pages 518-544, September.
  63. Ravikumar, B & Wallace, Neil, 2002. "A benefit of uniform currency," MPRA Paper 22951, University Library of Munich, Germany.
  64. Sik Kim, Young, 1996. "Money, barter, and costly information acquisition," Journal of Monetary Economics, Elsevier, vol. 37(1), pages 119-142, February.
  65. William McBride & Kurt Schuler, 2012. "Where Is Private Note Issue Legal?," Cato Journal, Cato Journal, Cato Institute, vol. 32(2), pages 395-410, Spring/Su.
  66. Guillaume Rocheteau & Christopher J. Waller, 2005. "Bargaining and the value of money," Working Paper 0501, Federal Reserve Bank of Cleveland.
  67. Kenneth Rogoff, 1998. "Blessing or curse? Foreign and underground demand for euro notes," Economic Policy, CEPR;CES;MSH, vol. 13(26), pages 261-303, 04.
  68. Alberto Trejos & Randall Wright, 1996. "Search-theoretic models of international currency," Proceedings, Federal Reserve Bank of St. Louis, issue May, pages 117-132.
  69. Paul R. Krugman, 1984. "The International Role of the Dollar: Theory and Prospect," NBER Chapters, in: Exchange Rate Theory and Practice, pages 261-278 National Bureau of Economic Research, Inc.
  70. Dutta, Rohan, 2012. "Bargaining with revoking costs," Games and Economic Behavior, Elsevier, vol. 74(1), pages 144-153.
  71. Kydland, Finn E & Prescott, Edward C, 1977. "Rules Rather Than Discretion: The Inconsistency of Optimal Plans," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 473-91, June.
  72. Ruilin Zhou, 1997. "Currency Exchange in a Random Search Model," Review of Economic Studies, Oxford University Press, vol. 64(2), pages 289-310.
  73. Rebecca Hellerstein & William Ryan, 2009. "The determinants of international flows of U.S. currency," Staff Reports 400, Federal Reserve Bank of New York.
  74. Wright Randall & Trejos Alberto, 2001. "International Currency," The B.E. Journal of Macroeconomics, De Gruyter, vol. 1(1), pages 1-17, April.
  75. John Kareken & Neil Wallace, 1981. "On the Indeterminacy of Equilibrium Exchange Rates," The Quarterly Journal of Economics, Oxford University Press, vol. 96(2), pages 207-222.
  76. Camera, Gabriele & Winkler, Johannes, 2003. "International monetary trade and the law of one price," Journal of Monetary Economics, Elsevier, vol. 50(7), pages 1531-1553, October.
  77. Andolfatto, David, 2013. "Incentive-feasible deflation," Journal of Monetary Economics, Elsevier, vol. 60(4), pages 383-390.
  78. Engineer, Merwan, 2000. "Currency transactions costs and competing fiat currencies," Journal of International Economics, Elsevier, vol. 52(1), pages 113-136, October.
  79. Barry Eichengreen & Marc Flandreau, 2010. "The Federal Reserve, the Bank of England and the rise of the dollar as an international currency, 1914-39," BIS Working Papers 328, Bank for International Settlements.
  80. Friberg, Richard & Wilander, Fredrik, 2007. "Price Setting Transactions and the Role of Denominating Currency in FX Markets," Working Paper Series 201, Sveriges Riksbank (Central Bank of Sweden).
Full references (including those not matched with items on IDEAS)

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

When requesting a correction, please mention this item's handle: RePEc:pra:mprapa:42114. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Joachim Winter)

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.

This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.