DP19078 Privilege Lost? The Rise and Fall of a Dominant Global Currency
How does a country obtain the status of a safe haven with a dominant global currency? This paper argues that size matters: as a country becomes larger and more diversified, the underlying shock process of the economy becomes less variable. Shocks that can drive a government to default become less likely, implying lower default probability, lower interest rates and a larger debt capacity. Furthermore, the larger a country’s share in the supply of global safe assets, the more liquid and attractive its bonds are for investors. If the dominant currency country grows less than the rest of the world, its status as a safe haven erodes and interest rate differentials decline. We also discuss how the structure of shocks, a country`s institutional features and financial development matter for its role as a global currency.
