Collateral Advantage: Exchange Rates, Capital Flows and Global Cycles / Michael B. Devereux, Charles Engel, Steve Pak Yeung Wu.

Format:

Book

Author/Creator:

Devereux, Michael B.

Contributor:

National Bureau of Economic Research.

Engel, Charles.

Wu, Steve Pak Yeung.

Series:

Working Paper Series (National Bureau of Economic Research) no. w31164.

NBER working paper series no. w31164

Language:

English

Physical Description:

1 online resource: illustrations (black and white);

Place of Publication:

Cambridge, Mass. National Bureau of Economic Research 2023.

Summary:

We construct a two-country New Keynesian model in which US government debt has an advantage as a superior collateral asset in the balance sheets of banks. The model can account for the observed response of the US dollar and US bond returns to a global downturn, in particular when the downturn is associated with a global financial crisis. In our model, the U.S. enjoys an "exorbitant privilege" as its government bonds are desired by banks both in the U.S. and abroad as superior collateral. In times of global stress, the dollar appreciates and the "convenience yield" earned by U.S. government bonds increases. There is "retrenchment" - each country reduces its holdings of foreign assets - a critical determinant of which is the endogenous response of prices and returns. In addition, the model displays a U.S. real exchange rate appreciation despite that domestic absorption in the US falls relative to the rest of the world during a global downturn, thus addressing the "reserve currency paradox" highlighted by Maggiori (2017).

Notes:

Print version record

April 2023.