The Macroeconomic Implications of a Key Currency

Matthew Canzoneri, Robert Cumby (), Behzad Diba and David Lopez-Salido

No 14242, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: What are the macroeconomic consequences of the dominant role of the dollar in the international monetary system? Here, we present a calibrated two country model in which exports are invoiced in the key currency, and government bonds denominated in the key currency are held internationally to facilitate trade. Domestic government bonds and money are held in each country to facilitate domestic transactions. Our model generates deviations from uncovered interest parity that are as volatile as some empirical estimates, but much too small by others. Our model also speaks to some other empirical anomalies, such as the Backus - Smith puzzle. Shocks affecting asset supplies -- such as bond financed tax cuts, and open market operations -- have large effects in our model because they generate non-Ricardian changes in household wealth. Generally, shocks emanating from the key currency country do more to destabilize the world economy than equal sized shocks coming from the other country. Similarly, monetary and fiscal policy innovations in the key currency country are more potent than those in the other country. On the other hand, the key currency country is more vulnerable to financial market turbulence, such as a sell off of key currency bonds, which can lower consumption dramatically.

JEL-codes: F3 F4 F41 (search for similar items in EconPapers)
Date: 2008-08
New Economics Papers: this item is included in nep-cba, nep-mac, nep-mon and nep-opm
Note: IFM
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (7)

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Working Paper: Macroeconomic Implications of a Key Currency (2008)
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