Information Costs and International Currencies

This paper develops a unified framework for examining international payment patterns. Using an open-economy search model with competing monetary assets, I show how information costs and government transaction policies interact to produce a structure of world payments reminiscent with what is observed in practice. Agents’ decision to acquire information shapes exchange patterns by affecting a currency’s usefulness in trade— or, its liquidity. Due to network effects and complementarities in optimal choices, there is persistence and hysteresis in monetary leadership, even if the payment pattern is socially inefficient. While high inflation can lead to dollarization, a sufficiently large local government can de-dollarize the economy by inducing a switch to national currency use. By using simple transaction policies that promote the use of local money, governments can reverse exchange patterns, despite inertia. A calibration of the generalized model shows how changes in information costs or inflation can make hegemony shift from a dollar-dominated monetary system to a multi-polar regime. The welfare benefits of having an international currency are also discussed and compared with previous estimates.