Three essays on key currencies and currency blocs
Economists have long been aware that international financial markets are characterized by the widespread use of a few key currencies to which many other currencies are formally or informally pegged. Yet little effort has been made either to explain these phenomena of key currencies and currency blocs, or to understand their implications for exchange rate behavior and policy independence in open economies. This dissertation attempts to fill this gap in the literature, arguing that key currencies play a critical role in structuring international portfolio behavior, exchange rate movements, and the effectiveness of macroeconomic policy.
The first essay, "Exchange Rates, Interest Rates and Key Currencies" presents data on the bloc-like behavior of currencies the 1980s and tests a monetary model of exchange rate behavior for ten bilateral exchange rates, providing evidence for the centrality of the dollar-mark and dollar-yen axes in coordinating exchange rate behavior.
"The Underpinnings of International Currency Use" analyzes the microeconomic rationales that prompt key currency use. Arguing that international currencies will be held in proportion to the multinational industrial and banking activity of the issuing country, this essay develops and tests a panel data set of international currency usage. We find compelling empirical evidence for the relationship between portfolio composition and international industrial preeminence.
The final essay, "An Open-Economy Macroeconomic Model with Key Currencies and Currency Blocs", incorporates the evidence of prior essays into an open-economy macroeconomic model. By explicitly formalizing the existence of key currencies, the bloc-like behavior exchange rates, and the centrality of multinational preeminence we obtain results that diverge sharply from previous treatments. The analysis suggests that, with extensive capital mobility, the scope for independent macroeconomic policy is asymmetric, with small countries facing stronger and key countries weaker constraints on independent macroeconomic policy than earlier models had predicted.