The International Monetary System (IMS) is to a large extent based on one leading currency, the US Dollar (USD) and a small number of other currencies with some international importance, e.g. the Euro (EUR) or the British Pound (GBP). International leadership implies that one currency fulfills, to a great extent, the role of unit of account, store of value and medium of exchange. Historically, we can count less than a hand full of leading currencies in the last centuries. The Dutch Guilder preceded the GBP, which in turn has been dethroned by the USD. Remarkably, each currency maintained its leading position for decades or even centuries. For example, the creation of the EUR in 1999 did not contest the USD’s position to date. Moreover, aspiring currencies such as the Chinese Yuan (CNY), the Brazilian Real, the Indian Rupee and others may defy the actual organization of the IMS. Thus, whether the USD can maintain its position in this currency competition critically hinges on the determinants of being the leading currency. Surprisingly, not much economic research has been devoted to address currency competition or even war, and the systematic study of the determinants of a leading currency.

-        The central topic of this research proposal is currency competition – the competition that takes place between currencies resulting in a leadership of a currency lasting for a long period. Despite its relevance this topic has been largely neglected in macroeconomic theory. Why so few leading international currencies existed and the long-run determinants of their rise and fall have yet to be explored. The latter will be studied along the concrete short-run example of the design of optimal monetary policy. Our approach is in sharp contrast to the existing literature which emphasizes the benefits of international policy cooperation. We study currency war, a manifestation of currency competition and the unstudied opposite scenario of what has been examined. In sum, we develop a new branch of international macroeconomic research by modeling currency competition from both, a long- and short-run perspective.

-        Long-run: Most of the existing research has an historical and empirical perspective, but theoretical models on currency competition are scarce. The works of Dowd and Greenaway (1993), Hartmann (1998) and Li and Matsui (2009) constitute examples of models that study some of the determinants of currency competition using Game Theory (GT). However, these models involve only a small set of determinants of currency competition and limit the analysis to comparative statics. Hartmann (1998) sums the potential determinants of currency competition: switching costs, transaction costs, monopoly power in issuing money, network externalities, economies of scale, volume of trade, size of the country, monetary and exchange rate policy, macroeconomic conditions such as inflation and exchange rate variability, the role of vehicle currency and inertia in dislodging the leading currency. What is missing in the literature is a macroeconomic perspective on currency competition. Our proposed research also builds on concepts from GT and Industrial Organization (IO), but considers the interaction of multiple determinants of a leading currency and allows for studying the leading currency’s rise and fall, i.e. the transition dynamics.

-        Short-run: The literature on optimal monetary policy and international coordination is a fertile strand of research, with some breakthrough work of Clarida et al. (2002), Corsetti and Pesenti (2005) and Benigno and Benigno (2006) analyzing it in dynamic stochastic general equilibrium models (DSGEM) with nominal rigidities. We will introduce currency war by means of exchange rate manipulation as an extreme case of currency competition to this framework. The analysis utilizes robust optimal control techniques, as they allow us to capture the characteristics of exchange rate manipulation. The latter is a tool to affect many of the potential long-run determinants for currency leaders mentioned, e.g. switching costs. Moreover, it is available to any central bank and it has huge practical relevance, as the ongoing discussion about the potential hazard to the USA economy due to China’ exchange rate manipulation shows.

-        The main contributions of the proposed research can be summarized as follows: we identify the key determinants of currency competition and the implied strategies to become a leading currency. We also expect to obtain policy recommendations on how to optimally respond to exchange rate manipulation by aspiring currencies’ central banks.

No records found.

No records found.

No records found.

No records found.

No records found.

No records found.