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Vehicle Currency

Author

Listed:
  • 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.

Suggested Citation

  • Michael B. Devereux & Shouyong Shi, 2008. "Vehicle Currency," Working Papers tecipa-315, University of Toronto, Department of Economics.
  • Handle: RePEc:tor:tecipa:tecipa-315
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    File URL: https://www.economics.utoronto.ca/public/workingPapers/tecipa-315.pdf
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    Other versions of this item:

    • 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, February.

    References listed on IDEAS

    as
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    3. 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.
    4. Hartmann,Philipp, 2007. "Currency Competition and Foreign Exchange Markets," Cambridge Books, Cambridge University Press, number 9780521046930.
    5. 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.
    6. Goldberg, Linda S. & Tille, Cédric, 2008. "Vehicle currency use in international trade," Journal of International Economics, Elsevier, vol. 76(2), pages 177-192, December.
    7. Ronald McKinnon & Gunther Schnabl, 2004. "The East Asian Dollar Standard, Fear of Floating, and Original Sin," Review of Development Economics, Wiley Blackwell, vol. 8(3), pages 331-360, August.
    8. 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, March.
    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 937-968, October.
    10. 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.
    11. 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, May.
    12. 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.
    13. Wright Randall & Trejos Alberto, 2001. "International Currency," The B.E. Journal of Macroeconomics, De Gruyter, vol. 1(1), pages 1-17, April.
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    Citations

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    Cited by:

    1. Goldberg, Linda S. & Tille, Cédric, 2008. "Vehicle currency use in international trade," Journal of International Economics, Elsevier, vol. 76(2), pages 177-192, December.
    2. Menzie Chinn & Jeffrey A. Frankel, 2007. "Will the Euro Eventually Surpass the Dollar as Leading International Reserve Currency?," NBER Chapters,in: G7 Current Account Imbalances: Sustainability and Adjustment, pages 283-338 National Bureau of Economic Research, Inc.
    3. Parker, Miles, 2016. "How exporters set prices: evidence from a large behavioural survey," Working Paper Series 1974, European Central Bank.
    4. repec:bla:ecinqu:v:55:y:2017:i:4:p:1648-1670 is not listed on IDEAS
    5. Linda S. Goldberg & Cedric Tille, 2006. "The internationalization of the dollar and trade balance adjustment," Staff Reports 255, Federal Reserve Bank of New York.
    6. 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.
    7. Cova, Pietro & Pagano, Patrizio & Pisani, Massimiliano, 2016. "Foreign exchange reserve diversification and the “exorbitant privilege”: Global macroeconomic effects," Journal of International Money and Finance, Elsevier, vol. 67(C), pages 82-101.
    8. Kannan, Prakash, 2009. "On the welfare benefits of an international currency," European Economic Review, Elsevier, vol. 53(5), pages 588-606, July.
    9. Chung, Wanyu, 2016. "Imported inputs and invoicing currency choice: Theory and evidence from UK transaction data," Journal of International Economics, Elsevier, vol. 99(C), pages 237-250.
    10. Goldberg, Linda & Tille, Cédric, 2013. "A bargaining theory of trade invoicing and pricing," Kiel Working Papers 1839, Kiel Institute for the World Economy (IfW).
    11. 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, vol. 37(C), pages 371-393.
    12. Wanyu Chung, 2014. "Imported Inputs and Invoicing Currency Choice: Theory and Evidence from UK Transaction Data," Discussion Papers 2014-11, University of Nottingham, GEP.
    13. Pietro Cova & Patrizio Pagano & Massimiliano Pisani, 2016. "Global macroeconomic effects of exiting from unconventional monetary policy," Temi di discussione (Economic working papers) 1078, Bank of Italy, Economic Research and International Relations Area.
    14. Jung, Kuk Mo & Pyun, Ju Hyun, 2016. "International reserves for emerging economies: A liquidity approach," Journal of International Money and Finance, Elsevier, vol. 68(C), pages 230-257.
    15. Maria V. Sokolova, 2016. "Better More Than One: Portfolio Currency Pricing and Exchange Rate Hedging," IHEID Working Papers 03-2016, Economics Section, The Graduate Institute of International Studies.
    16. Pietro Cova & Patrizio Pagano & Massimiliano Pisani, 2015. "Domestic and international macroeconomic effects of the Eurosystem expanded asset purchase programme," Temi di discussione (Economic working papers) 1036, Bank of Italy, Economic Research and International Relations Area.
    17. Goldberg, Linda S. & Tille, Cédric, 2016. "Micro, macro, and strategic forces in international trade invoicing: Synthesis and novel patterns," Journal of International Economics, Elsevier, vol. 102(C), pages 173-187.
    18. repec:hrv:faseco:30780147 is not listed on IDEAS
    19. Cao, Shutao & Dong, Wei & Tomlin, Ben, 2015. "Pricing-to-market, currency invoicing and exchange rate pass-through to producer prices," Journal of International Money and Finance, Elsevier, vol. 58(C), pages 128-149.
    20. Lucas Herrenbrueck, 2017. "An Open-Economy Model With Money, Endogenous Search, And Heterogeneous Firms," Economic Inquiry, Western Economic Association International, vol. 55(4), pages 1648-1670, October.
    21. Zhang, Cathy, 2014. "An information-based theory of international currency," Journal of International Economics, Elsevier, vol. 93(2), pages 286-301.
    22. Pietro Cova & Patrizio Pagano & Massimiliano Pisani, 2014. "Foreign exchange reserve diversification and the "exorbitant privilege"," Temi di discussione (Economic working papers) 964, Bank of Italy, Economic Research and International Relations Area.
    23. Gita Gopinath, 2015. "The International Price System," NBER Working Papers 21646, National Bureau of Economic Research, Inc.
    24. Yang, Guangpu & Gu, Qingyang, 2016. "Effects of exchange rate variations on bilateral trade with a vehicle currency: Evidence from China and Singapore," Journal of International Money and Finance, Elsevier, vol. 68(C), pages 50-73.

    More about this item

    Keywords

    Vehicle currency; Transactions cost; Welfare gains;

    JEL classification:

    • F40 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - General
    • F30 - International Economics - - International Finance - - - General
    • E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Sytsems; Standards; Regimes; Government and the Monetary System

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