Foreign exchange reserve diversification and the “exorbitant privilege”: Global macroeconomic effects

• Published in: Journal of international money and finance 2016-10, Vol.67, p.82-101
• Main Authors: Cova, Pietro, Pagano, Patrizio, Pisani, Massimiliano
• Format: Article
• Language: English
• Subjects: Dynamic general equilibrium modeling; Eurozone; Foreign exchange rates; Global currency; Global imbalances; Interest rates; Keynesian theory; Macroeconomics; Studies; Trade surplus; Welfare economics
• ISSN: 0261-5606; 1873-0639
• DOI: 10.1016/j.jimonfin.2015.06.012

•We assess macro implications for global economy of official reserve management.•We develop a model calibrated to euro area, United States, China, and the rest of the world.•Higher global demand of euros reduces interest rate and boosts aggregate demand in euro area.•Lower global demand of dollars lowers aggregate demand in the United States.•Countries accumulating reserves run trade surplus. We assess the macroeconomic implications for the global economy of different strategies of official reserve management by developing a large scale new-Keynesian dynamic general equilibrium model, calibrated to the euro area, the United States, China and the rest of the world. An increase in the 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 aggregate demand falls because of higher interest rates, 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.