Global Monetary Policy Under a Dollar Standard

For the past four or five decades, the international monetary system has operated on a ?dollar standard?. Popular discussion suggests that this gives the US an advantage in the use of monetary policy. This Paper analyses the determination of monetary policy in a world with a dollar standard, defined here as a environment in which all traded goods prices are set in US dollars. This generates an asymmetry whereby exchange rate pass-through into the US CPI is zero, while pass-through to other countries will be positive. We show that monetary policy in such a setting does seem to accord with popular discussion. In particular, the US is essentially indifferent to exchange rate volatility in setting monetary policy, while the rest of the world places a high weight on exchange rate volatility. More importantly, in a Nash equilibrium of the monetary policy game between the US and the rest of the world, the preferences of the US dominate. That is, the equilibrium is identical to one where the US alone chooses world monetary policy. Despite this, we find surprisingly that the US loses from the dollar?s role as an international currency. Even though US preferences dominate world monetary policy, the absence of exchange rate pass-through means that US consumers are worse off than those in the rest of the world, where exchange rate pass-through operates efficiently. Finally, we derive the conditions for a dollar standard to exist.