Determinants shaping the international currency system: Where do currencies stand relative to their equilibria?

• Date: 01 February 2020
• Published date: 01 February 2020
• DOI: http://doi.org/10.1111/twec.12853
• Author: Manuel Duarte Rocha,Maria Siranova

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wileyonlinelibrary.com/journal/twec World Econ. 2020;43:458–483.

© 2019 John Wiley & Sons Ltd

Received: 28 March 2018

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Revised: 30 April 2019

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Accepted: 22 May 2019

DOI: 10.1111/twec.12853

ORIGINAL ARTICLE

Determinants shaping the international currency

system: Where do currencies stand relative to their

equilibria?

MariaSiranova1,2

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Manuel DuarteRocha3,4,5

1University of Economics in Bratislava, Bratislava, Slovakia

2Institute of Economic Research,Slovak Academy of Sciences, Bratislava, Slovakia

3FEP – Faculdade de Economia,Universidade do Porto, Porto, Portugal

4CEF.UP – Center for Economics and Finance at University of Porto,Faculdade de Economia,Universidade do Porto, Porto,

Portugal

5NIFIP – Núcleo de Investigação em Finanças Públicas e Política Monetária,Faculdade de Economia,Universidade do Porto,

Porto, Portugal

Funding information

FCT (Fundação para a Ciência e a Tecnologia), Grant/Award Number: POCI‐01‐0145‐FEDER‐006890; European Regional

Development Fund through COMPETE 2020—Programa Operacional Competitividade e Internacionalização (POCI); Slovak

Scientific Grant Agency, Grant/Award Number: APVV‐15‐0666; Vedecká Grantová Agentúra MŠVVaŠ SR a SAV, Grant/

Award Number: 1/0613/18

KEYWORDS

dollar, emerging market economies, euro, international currency, international monetary system, renminbi

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INTRODUCTION

The question of whether the US dollar risks losing its long‐time international currency dominance has been

increasingly debated (e.g., Chinn & Frankel, 2008; Cohen, 2003; Lee, 2014; McKinnon, 2002; Prasad,

2014), with the euro and the Chinese renminbi standing out as candidates to be able to do so. The dollar's

loss of dominant position in the international monetary system would have severe consequences, not only

for the US economy but also for countries linked to it by some form of managed exchange rate regime, as

indeed it would have for the global economy as a whole, given the underlying adjustment process.

The importance of this question has been enhanced as the strength of the euro has been shaking in

the light of the Eurozone crisis while that of the renminbi has been benefiting from China's growing

economic importance and role in international trade and finance, topped with the very recent

International Monetary Fund's decision to include the renminbi in the basket of currencies comprising

the Special Drawing Right (SDR). Further momentum for this question has been gained with Brexit,

which is bound to shift the attention also to the consequences of the UK leaving the EU for both the

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SIRANOVA ANd ROCHA

British pound and the euro—this brings back the question of whether the euro may become a stronger

competitor by the increased financial depth that may be gained from the loss of importance of London

as a financial centre.1

The present work contributes to this discussion along four avenues. First, although economic theory

suggests a multiplicity of factors that may determine the currencies' status in the international monetary

system, its empirical analysis remains limited. In this context, the present work contributes by empirically

testing the role of a set of determining factors that is, to the best of our knowledge, markedly the largest ever

tested, including 34 factors distributed in three groups of indicators. To the best of our knowledge, this is the

first study to empirically assess the role of institutional indicators and also to show that multiple dimensions

of financial development and openness matter in determining international currency shares. Second, we are

also the first, to the best of our knowledge, to carry out this kind of assessment on the basis of a combined

measure of currency use, which we propose in this work, and that encompasses the different functions of an

international currency. Third, while the literature has been focusing on examining the status of a few major

international currencies, we take into account a much broader set of 27 currencies (including advanced

and emerging market economies), which allows for a far more comprehensive view of the structure of the

international currency system and takes into consideration the potential from emerging currencies. Lastly,

we provide a score of individual currencies' potential stemming from the determinants by calculating the

long‐run equilibrium values of their shares, which allows for a view of the currency composition of the

international monetary system according to currencies' potential standing.

By identifying determinants of the international status of currencies, our work aims to contribute

to understanding the key forces underlying the international currency system. This knowledge is of

the utmost importance for the debate on the reform of the international monetary system, not only

from an academic and policymaking point of view, but also for practitioners. Moreover, our scoring

exercise may be of guidance for policymakers aiming to maximise the possibilities for improving their

currencies' rank in the international currency system.

This work is structured as follows. In the next section, we discuss the definition of international

currency and provide an overview of the literature regarding the determinants that may affect the

currencies' standings in the international monetary system. The following section describes the data

and the methodology, including the construction of a global indicator of currency use, the models esti-

mated and the calculation of the equilibrium values of currency use. The penultimate section presents

the empirical findings, and the final section concludes.

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LITERATURE OVERVIEW

The literature on international currencies is vast. It received an especially increasing attention since

the late nineties, when the euro was introduced (e.g., Cohen, 2003; Eichengreen, 1998; Hartmann &

Issing, 2002; Kenen, 2002; Lim, 2006; McCauley, 1997; McKinnon, 2002), while more recently it

has been fuelled by the ongoing debate on the new structure of the international monetary system and

the position of the Chinese renminbi in it (e.g., Dobson & Masson, 2009; Eichengreen, 2011; Maziad,

Farahmand, Wang, Segal, & Ahmed, 2011; Prasad & Ye, 2012).

Most empirical studies primarily focus on the study of reserve currencies that are dominant in the

international monetary system (e.g., US dollar, euro, pound sterling, Japanese yen), with very few

providing an analysis of the status of a larger set of currencies (such as Maziad et al., 2011; Thimann,

1 A scenario that was already under the attention in this line of research even before Brexit, as may be seen in the simulations

by Chinn and Frankel (2008).