Working Paper: NBER ID: w1120
Authors: Willem H. Buiter; Jonathan Eaton
Abstract: This paper explores some implications of the use of national currencies as international reserves. First, a closed economy overlapping-generations model is developed to derive time-consistent tax and inflation policies for a government that is financing a given stream of expenditures. Second, the effects of allowing a government to hold a foreign currency as a reserve asset and to have its currency held as a reserve asset abroad are considered. The use of national currencies as currencies of denomination for international lending creates an incentive for the governments whose currencies are used to alter their inflation rates to extract resources from the rest of the world. When reserves are constrained to be nonnegative the use of national currencies as international reserves raises the inflation rate in reserve issuing countries but does not effect theiInflation rate in reserve holders. The opposite result arises when loans are denominated in the borrowers' currencies.
Keywords: International reserves; Inflation; Monetary policy; Overlapping generations model
JEL Codes: F30; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| national currencies as international reserves (F33) | inflation rate in reserve-issuing countries (E31) |
| inflation rate (E31) | reserve holders (E58) |
| currency denomination of loans (F34) | inflation outcomes (E31) |
| high inflation rates (E31) | lenders (when loans are denominated in their own currency) (F34) |
| foreign holdings of domestic currency (F31) | inflation rate in issuing country (E31) |