A Dual-Pronged Approach to Currency Internationalization

Abstract

Policies aimed at promoting currency internationalization often target frictions in both capital and current account transactions. We study this dual-pronged approach using a dynamic general equilibrium model in which an international currency serves as both a store of value and a medium of exchange. Due to the complementarity between different functions of an international currency, a dual-pronged approach is more effective than policies with a single focus. We analytically characterize this policy complementarity and apply the model to China's renminbi internationalization reforms during 2010-2021. We find that (1) these reforms reduced the return wedge on foreign held renminbi bonds by 4.1% and lowered the cost of renminbi-settled international trade by 0.9%; (2) policy complementarity accounted for half of the overall policy effect; (3) a single-focused policy-targeting only capital (current) account frictions-would have raised fiscal costs by a factor of 2.1 (1.8).

Keywords: Renminbi Internationalization, Policy Complementarity, Capital Account Liberalization