Emile Marin (University of Cambridge)

Abstract: By keeping dollars scarce in international markets, the U.S. -- the hegemon -- earns monopoly rents when borrowing in dollar debt and investing in foreign currency assets. However, in equilibrium, these rents both result in a strong dollar, which depresses global demand for its exports and leads to losses on existing holdings of foreign assets, and give rise to private sector over-borrowing. Using an open economy model with nominal rigidities and segmented financial markets, I show that, because of over-borrowing, monetary and fiscal policy alone cannot achieve the constrained efficient allocation. Absent a corrective macro-prudential tax on capital inflows, the hegemon is faced with a policy dilemma between achieving efficient stabilization \emph{or} maximizing monopoly rents. By increasing liquidity in international markets, dollar swap lines extended by the central bank improve stabilization, but, unlike macro-prudential taxes, do so at the cost of eroding monopoly rents. The dilemma matters for distribution as well as efficiency. A scarce dollar leads to larger monopoly rents which benefit financially-active households, but they over-borrow at the expense of inactive households, who suffer the full blunt of aggregate demand externalities.