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VEHICLE CURRENCY

Authors

  • Michael B. Devereux,

    1. University of British Columbia and NBEr, Canada; University of Toronto and CUFE, Canada
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  • Shouyong Shi

    1. University of British Columbia and NBEr, Canada; University of Toronto and CUFE, Canada
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    • Two referees and the editor provided valuable comments on a previous draft. We thank Randy Wright, Neil Wallace, Cedric Tille, Nancy Stokey, Bob Lucas, and V.V. Chari for comments and discussions. We have also received valuable comments from the participants of seminars and conferences. Both authors gratefully acknowledge financial support from SSHRC and the Bank of Canada Fellowship. Devereux also acknowledges financial assistance from Target and the Royal Bank of Canada, and Shi acknowledges financial support from the Canada Research Chair. The opinions expressed in this article are the authors’ own and they do not represent the view of the Bank of Canada. Please address correspondence to: Michael B. Devereux, Department of Economics, University of British Columbia, 997-1873 East Mall, Vancouver, BC, Canada V6T 1Z1. E-mail: devm@interchange.ubc.ca.


  • Manuscript received October 2010; revised October 2011.

Abstract

Historically, the world economy has been dominated by a single currency accepted in the exchange of goods and assets among countries. In recent decades, the U.S. dollar has played this role. The dollar acts as a “vehicle currency” in the sense that agents in nondollar economies will generally engage in currency trade indirectly using the U.S. dollar instead of using direct bilateral trade among their own currencies. A vehicle currency is desirable when there are transactions costs of exchange. This article constructs a dynamic general equilibrium model of a vehicle currency. We explore the nature of the efficiency gains arising from a vehicle currency and show how it depends on the total number of currencies in existence, the size of the vehicle currency economy, and the monetary policy followed by the vehicle currency’s government. We find that there can be significant welfare gains to a vehicle currency in a system of many independent currencies. But these gains are asymmetrically weighted toward the residents of the vehicle currency country. The survival of a vehicle currency places natural limits on the monetary policy of the vehicle currency country.

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