Foreign Exchange Reserve Diversification and the 'Exorbitant Privilege'

61 Pages Posted: 18 Nov 2014

Date Written: July 18, 2014

Abstract

We assess the global macroeconomic implications of different strategies of official reserve management by developing a large scale new-Keynesian dynamic general equilibrium model of the world economy, calibrated on the euro area, the United States, China, Japan and the rest of the world. An increase in global demand for euros would boost euro-area aggregate demand because of the reduction in euro-area interest rates (the main benefit associated with the “privilege” of being a global currency). If the higher demand for euros is associated with lower demand for US dollars, then US economic activity falls because of higher interest rates, which depress domestic aggregate demand, while the external balance improves; countries accumulating reserves continue to run a trade surplus, as exports to the euro-area increase. We also compute welfare gains/costs for all economies.

Keywords: global imbalances, global currency, dynamic general equilibrium modelling

JEL Classification: F33, F41, C51, E52

Suggested Citation

Cova, Pietro and Pagano, Patrizio and Pisani, Massimiliano, Foreign Exchange Reserve Diversification and the 'Exorbitant Privilege' (July 18, 2014). Bank of Italy Temi di Discussione (Working Paper) No. 964. Available at SSRN: https://ssrn.com/abstract=2526085 or http://dx.doi.org/10.2139/ssrn.2526085

Pietro Cova

Bank of Italy ( email )

Via Nazionale 91
Rome, 00184
Italy

Patrizio Pagano

Bank of Italy ( email )

Via Nazionale 91
Rome, 00184
Italy

Massimiliano Pisani (Contact Author)

Bank of Italy ( email )

Via Nazionale 91
Rome, 00184
Italy

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