Working Paper: CEPR ID: DP4317
Authors: Michael B. Devereux; Kang Shi; Juanyi Xu
Abstract: For the past four or five decades, the international monetary system has operated on a ?dollar standard?. Popular discussion suggests that this gives the US an advantage in the use of monetary policy. This Paper analyses the determination of monetary policy in a world with a dollar standard, defined here as a environment in which all traded goods prices are set in US dollars. This generates an asymmetry whereby exchange rate pass-through into the US CPI is zero, while pass-through to other countries will be positive. We show that monetary policy in such a setting does seem to accord with popular discussion. In particular, the US is essentially indifferent to exchange rate volatility in setting monetary policy, while the rest of the world places a high weight on exchange rate volatility. More importantly, in a Nash equilibrium of the monetary policy game between the US and the rest of the world, the preferences of the US dominate. That is, the equilibrium is identical to one where the US alone chooses world monetary policy. Despite this, we find surprisingly that the US loses from the dollar?s role as an international currency. Even though US preferences dominate world monetary policy, the absence of exchange rate pass-through means that US consumers are worse off than those in the rest of the world, where exchange rate pass-through operates efficiently. Finally, we derive the conditions for a dollar standard to exist.
Keywords: International Currency; Monetary Policy; US Dollar
JEL Codes: F00; F40
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| US dollar standard (F33) | US experiences zero exchange rate passthrough into CPI (F31) |
| US dollar standard (F33) | other countries experience positive exchange rate passthrough (F31) |
| zero exchange rate passthrough into CPI (F31) | US monetary policy largely unaffected by exchange rate fluctuations (F31) |
| positive exchange rate passthrough (F31) | other countries must account for exchange rate fluctuations in policy frameworks (F31) |
| US dollar standard (F33) | US dominates monetary policy game (E49) |
| US dominance in monetary policy game (E49) | US preferences dictate global monetary policy (F01) |
| US preferences dictate global monetary policy (F01) | Nash equilibrium (C72) |
| US dollar standard (F33) | US residents worse off due to lack of passthrough effects (H29) |
| lack of passthrough effects (H23) | inhibits efficient response to relative price changes caused by real shocks (E31) |