The dollar’s international role: An “exorbitant privilege”?

Ben S. Bernanke

This post is the third of three based on my Mundell-Fleming lecture, which discussed the international effects of Fed policy. In the two previous posts (see here and here), I addressed a pair of criticisms of recent U.S. monetary policy: (1) that the U.S. had engaged in “currency wars” by depreciating the dollar for competitive advantage in trade; and (2) that shifts in U.S. monetary policy have had spillover effects on financial stability in other countries, especially emerging markets.

These debates raise yet another question: Why is the Fed the principal subject of such critiques, even though other major central banks have also engaged in aggressive monetary policies? A common answer is that the dominant role of the U.S. dollar in international trade and finance—about 60 percent of international reserves are held in dollar-denominated assets, for example—makes Fed actions particularly consequential. That in turn, it is sometimes argued, confers a special responsibility on U.S. policymakers to take the international implications of their actions into account.

Why is the dollar the most often-used global currency? Does the dollar’s international role unfairly advantage the United States, to the detriment of other countries? Does the dollar’s role magnify the effects of Fed actions on other countries, and if so, how? I’ll touch on these questions in this post. I’ll argue that the benefits of the dollar’s status to the United States have been much reduced in recent decades, and that a principal channel of the Fed’s international influence works through dollarized credit markets.

The dollar’s international role has evolved since World War II. During the early postwar period, under a 1944 agreement negotiated by the U.S. and its allies at Bretton Woods, New Hampshire, other currencies were pegged to the dollar while the dollar was (loosely) pegged to gold (see here for a discussion of how the Bretton Woods framework related to other international monetary systems). The goal was to replace the gold standard, which had collapsed during the Depression, with something more flexible. In practice, however, the system afforded the greatest flexibility to the United States, which enjoyed substantial freedom to pursue its domestic policy objectives as well as the ability to run sustained balance-of-payments deficits. The latter, according to French finance minister Valéry Giscard d’Estaing, gave the United States an “exorbitant privilege.” The Bretton Woods system ultimately broke down in part because the U.S., as the “anchor” country, didn’t live up to its obligation to maintain price stability. Since the early 1970’s the international monetary system has been effectively decentralized, with each country setting its own exchange-rate framework and with the values of the major currencies being determined by markets (“floating” rather than fixed exchanged rates).

The article’s full-text is available here.

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