Intertemporal Currency Substitution and Government Deficits
21 Pages Posted: 5 Nov 2006
Date Written: March 2006
This paper highlights the importance of having a strong alternative world currency in order to place a constraint on the ability of a single dominant world currency being able to extract resources from the rest of the world through monetary policy. The effects of monetisation of the budget deficit and the advantages of strong currencies over weaker ones arising from their use as an international store of value are investigated. We find that the long run the budget deficit does not need to be zero. This is because the inflation tax generates resource transfers to the country whose currency is the preferred international store of wealth. Furthermore, the trade balance does not need to be zero, providing there is currency substitution and asymmetry between countries. Thus, the results we obtain are strikingly different from any comparable work in the literature.
Keywords: budget deficits, monetary policy, currency substitution, inflation, exchange rates
JEL Classification: E52, E60, F30
Suggested Citation: Suggested Citation