An Equilibrium Model of the International Price System

Dmitry Mukhin
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Dmitry Mukhin: Princeton University

No 89, 2018 Meeting Papers from Society for Economic Dynamics

Abstract: The currency in which international prices are set is a factor of fundamental importance in international economics: it determines the benefits of floating versus pegged exchange rates and the spillover effects of national monetary policy on other economies. However, the standard assumption in existing models - that all prices are set in a currency of either the producer or the consumer - is inconsistent with two basic facts: the dominant status of the dollar in global trade and the radical transformation of the price system over history. In this paper, I develop a general equilibrium multi-country framework with endogenous currency choice that is consistent with these stylized facts and show that despite small costs for exporters, the aggregate effects of currency choice are large. First, I identify a novel source of positive U.S. monetary spillovers on foreign output that can outweigh the standard "beggar-thy-neighbor" effect. Second, I show that an optimal monetary policy implies a partial peg to the dollar, which is consistent with the "fear of floating" and the widespread use of the dollar as an anchor currency seen in the data.

Date: 2018
New Economics Papers: this item is included in nep-dge and nep-opm
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Persistent link: https://EconPapers.repec.org/RePEc:red:sed018:89

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