Working Paper: CEPR ID: DP18427
Authors: Georgios Georgiadis; Gernot Müller; Ben Schumann
Abstract: We develop a two-country business-cycle model of the US and the rest of the world with dollar dominance in trade invoicing, in cross-border credit, and in safe assets. The interplay between these elements---dollar trinity---rationalizes salient features of the Global Financial Cycle in the data: When its tide subsides, the dollar appreciates, financial conditions tighten, the world business cycle slows down, and emerging-market central banks face a trade-off between mitigating the recession and dampening price pressures. We find the dollar is no sideshow in this, but central for the transmission of the Global Financial Cycle to the world economy.
Keywords: Dollar Dominance; Dominant Currency Paradigm; Bayesian Proxy Structural VAR Model; Convenience Yield
JEL Codes: F31; F42; F44
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Dollar dominance in safe asset supply (F31) | Dollar appreciation (F31) |
| Increased global risk aversion (F65) | Dollar appreciation (F31) |
| Dollar appreciation (F31) | Tightening global financial conditions (F65) |
| Tightening global financial conditions (F65) | Slowing down the world business cycle (F44) |
| Dollar appreciation (F31) | Contraction of credit in emerging markets (F65) |
| Dollar dominance in trade invoicing (F31) | Tradeoff for emerging market central banks (F31) |
| Dollar appreciation (F31) | Raises import prices (F14) |
| Dollar appreciation (F31) | Output contraction (E31) |
| Dollar dominance across dimensions (F31) | Effects of global risk aversion on the world economy (F65) |
| Dollar dominance across dimensions (F31) | Financial amplification and policy tradeoffs (E44) |