DP13391 Dominant Currency Debt

Author(s): Egemen Eren, Semyon Malamud
Publication Date: December 2018
Date Revised: December 2018
Keyword(s): dollar debt, dominant currency, Exchange Rates, inflation
JEL(s): E44, E52, F33, F34, F41, F42, F44, G01, G15, G32
Programme Areas: Financial Economics, International Macroeconomics and Finance
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=13391

Why is the dollar the dominant currency for debt contracts and what are its macroeconomic implications? We develop an international general equilibrium model where firms optimally choose the currency composition of their debt. We show that there always exists a dominant currency debt equilibrium, in which all firms borrow in a single dominant currency. It is the currency of the country that effectively pursues aggressive expansionary monetary policy in global downturns, lowering real debt burdens of firms. We show that the dollar empirically fits this description, despite its short term safe haven properties. We provide further modern and historical empirical support for our mechanism across time and currencies. We use our model to study how the optimal monetary policy differs if the Federal Reserve reacts to global versus domestic conditions.