An Asymmetric Model on Seigniorage and the Dynamics of Net Foreign Assets

The emergence of international current account imbalances has dominated the economic debate for several years and has been considered one of the main reasons for the turbulences in the world economy since 2007. Economic theory suggests that an economy cannot run persistent current account deficits without depleting its net foreign assets. Nevertheless, for most of the 2000s the US net foreign liabilities grew at a rate below the one of the cumulative current account deficit. To investigate on the mechanisms that allow the US to do so, this paper sets up a two country DGE model with asymmetric liquidity constraints. The model will show that there is a permanent wealth transfer from the world to the US. The unique position of the US not only allows them to run persistent current account deficits, but also imposes a permanent decay on the American current account. As the issuer of the world key currency in an asymmetric world monetary system, the US can make use of Seigniorage and valuation effects to be able to run a continuous current account deficit. These mechanisms work in favour of their net foreign bond holdings, but let their CA further deteriorate. The corresponding one-way capital flows were part of the distortions that laid the ground for the world financial crisis 2007-2009. Future will show if a multi polar world with several (regional) reserve currencies emerges.