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But in the absence of capital controls, a key difference between private and public issuance becomes consequential: while the latter internalizes its effects on equilibrium interest rates, the former does not. Private issuance mitigates the monopoly power of the government by confronting it with a more elastic residual demand curve, but does not eliminate it as long as private issuance is not infinitely elastic. In the extended model, the proper notion of reserve supply is given by the total external debt: it is the basis for the monopoly rents of the country, and it also governs the incentives of the government to devalue.

We also consider an extension that accounts for issuance in the reserve currency by third parties, private or public, that are based in countries other than the hegemon. In our baseline model, taxes are not distortionary.


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F, we extend the model to capture the distortionary costs of taxation. We incorporate a social cost of public funds which proxies for a country's fiscal capacity. In practice, a country's fiscal capacity could be influenced by several factors, such as its size, the development of its tax administration, the strength of its legal system, and its enforcement capacity, and so forth. In general, larger fiscal capacities lead to more reserves issuance.

In a multipolar model with heterogenous issuers, the equilibrium is an asymmetric Cournot equilibrium where issuers with larger fiscal capacities have larger equilibrium market shares. Historically, a dominant position as a reserve currency has often been associated with dominance in the currency denomination of goods and other contracts. In other words, prices of tradable goods are disproportionately quoted in the dominant reserve currency, in dollars at present and in sterling in the s, a fact dubbed the international price system IPS by Gopinath F, we investigate the interaction between reserve currency status and currency of goods pricing and the rationales for their association.

The more goods are priced and sticky in a given reserve currency, the safer is the debt denominated in this currency, since a given nominal devaluation of this currency leads to a smaller erosion of the real value of the debt. In a multipolar model, this characteristic confers an advantage to the issuer of this currency. In our baseline model, the key characteristic of reserve assets is their safety, and their demand arises from the risk aversion of RoW investors.

In practice, reserve assets are distinguished not only by their safety but also by their liquidity. We allow the individual marginal liquidity benefits of holding the reserve asset to increase with the holdings of other agents, to capture the fundamental increasing returns or network property of liquidity. In a multipolar model, the increasing returns or network effects associated with liquidity can amplify the impact of differences fiscal capacity, reputation, currency of goods pricing across issuers and lead to the endogenous emergence of a hegemon.

This captures the widely-held notion that the depth and liquidity of U. Treasuries, is key in consolidating the role of the U. In our baseline model, entry is exogenous. G, we extend the model to allow for endogenous entry.

Foreign Holdings of U.S. Treasuries and U.S. Treasury Yields

We have in mind the various costs and delays in acquiring a reputation for sound policy. In practice, this could involve resisting the pressure to devalue in times of crisis at a potentially large economic cost. Furthermore, the opportunities to demonstrate good behavior to boost reputation might be very infrequent. The consequence is that the reserve currency market could have the characteristics of a natural monopoly with large fixed costs and low variable costs.

Entry costs must be recouped with a share of future total monopoly rents, and these might be too small to sustain entry by a large number of issuers. This line of explanation offers yet another rationale for the historically high concentration of the reserve currency market and for its limited contestability. It also offers another perspective on the endogenous emergence of a hegemon. Indeed, to the extent that the entry cost is sunk, the identity of the hegemon say, the United States at present could to some extent be the result of a historical accident through a form of first-mover advantage.

A reserve country that was at some point in the past in a dominant position on fundamental grounds, preserves its central position simply because it is already present in the market. This might impart persistence and lock-in effects to reserve currency status. One avenue to mitigate the Triffin dilemma and the associated instability of the IMS is to introduce policies that reduce the demand for reserve assets.

In their most recent incarnation, they have included swap lines among central banks, credit lines by the IMF as a LoLR, and international reserve sharing agreements such as the Chiang Mai initiative.

H, we augment our framework to make sense of these global financial safety net proposals. We assume that each of the many countries in RoW faces idiosyncratic shocks.

Chinese Central Bank Buying Treasuries

We also assume that risk aversion increases with the amount of risk faced by individual investors. This captures a form of precautionary saving motive whereby higher idiosyncratic risk leads to a higher demand for reserve assets.

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A risk-sharing arrangement between RoW countries mitigates the impact of idiosyncratic shocks and tilts portfolios away from reserve assets. Over and above its immediate idiosyncratic risk-sharing benefits, such an arrangement is beneficial because it reduces the demand for reserve assets, lowers the pressure for the hegemon to stretch itself by issuing in the instability zone and exposing itself to a confidence crisis, and mitigates the Triffin dilemma.

We have provided a simple and tractable framework for understanding the IMS. The framework helps rationalize a number of historical episodes, including the emergence and collapse of the gold-exchange standard in the s, the emergence and collapse of the Bretton Woods system, the recessionary forces associated with gold-exchange standards, and the role of the United States as a hegemon in the current floating exchange rate system.