Vehicle Currency

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 US dollar has played this role. The dollar acts as a ‘‘vehicle currency’’ in the sense that agents in non-dollar economies will generally engage in currency trade indirectly using the US dollar rather than using direct bilateral trade among their own currencies. A vehicle currency is desirable when there are transactions costs of exchange. This paper constructs a dynamic general equilibrium model of a vehicle currency. We explore the nature of the e ciency 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 nd that there can be signicant welfare gains to a vehicle currency in a system of many independent currencies. But these gains are asymmetrically weighted towards 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. JEL classications: F40, F30, E42.