This paper provides a theory on the endogenous formation of an International Monetary System (IMS). The baseline model of IMS in this paper builds upon the work of Gopinath and Stein (2018) and incorporates both a notion of heterogeneous Economic Distance between the emerging markets (EM) and the hegemons, and a heterogeneous debt underwriting cost borne by the EMs when issuing foreign debts. The motivation behind introducing these mechanisms is to help the original model match more closely with the empirical regularity that different EMs share heterogenous geographical distance and institutional closedness with the hegemons, which implies that they trade with the hegemons with varied intensities (Bergstrand, 1985), and are expected to have different hegemon currency invoicing s...[ Read more ]

This paper provides a theory on the endogenous formation of an International Monetary System (IMS). The baseline model of IMS in this paper builds upon the work of Gopinath and Stein (2018) and incorporates both a notion of heterogeneous Economic Distance between the emerging markets (EM) and the hegemons, and a heterogeneous debt underwriting cost borne by the EMs when issuing foreign debts. The motivation behind introducing these mechanisms is to help the original model match more closely with the empirical regularity that different EMs share heterogenous geographical distance and institutional closedness with the hegemons, which implies that they trade with the hegemons with varied intensities (Bergstrand, 1985), and are expected to have different hegemon currency invoicing shares (Ito and Chinn, 2014). Using the baseline model, I am also able to show that the parameter space sustaining different kinds of equilibria should have been much narrower. Furthermore, it turns out that the EM agents generally prefer an asymmetric USD dominant IMS over a symmetric IMS, but the same might not apply to the Euro bloc EMs that share a strong economic tie with the Eurozone. Nevertheless, this general preference for an asymmetric IMS might no longer hold when the baseline model is extended to incorporate the possibility of a Triffin-like confidence crisis pioneered by Farhi and Maggiori (2017). Faced with little competition, the hegemon under an asymmetric equilibrium tends to over-issue debts inside the instability zone. This brings them higher expected welfare at the expense of opening up the possibility of a confidence crisis, making the emerging markets worse off under an unstable asymmetric IMS, as compared with a stable symmetric IMS.