Large economies have natural advantage in currency dominance

The paper develops a micro-founded monetary model of the world economy to analyze international currency competition, featuring both "unipolar" (single dominant) and "multipolar" (multiple currencies) equilibria.

Long-run outcomes are highly history-dependent, with a strong tendency towards the emergence of a dominant currency.

Governments can compete by offering attractive interest rates on their sovereign debt to internationalize their currencies.

However, the study highlights that large economies possess a natural advantage in ensuring their currency's dominance, as foreign agents anticipate higher chances of trading with domestic agents who accept that currency.

This inherent advantage allows larger nations to maintain currency dominance even with higher liquidity premiums on their debt.

The model emphasizes money's role as an international medium of exchange, with government bonds potentially used for international trade in a search-and-matching market.

A critical assumption is that sellers must make a fixed-cost investment to recognize a foreign currency, considering future trade gains.

Strategic complementarities emerge: increased global acceptability of a country's bonds enhances demand for that currency, increasing the benefit of accepting it.

This creates a feedback loop where widespread acceptance reinforces demand, and vice-versa.

The authors calibrate these costs to be on the order of basis points of total trade quantities.