Dominant Invoicing Currency and Asymmetric Monetary Effects

We show how the U.S. dollar as the dominant invoicing currency in international trade causes the U.S. monetary policy to have asymmetric monetary effects. We develop a model of two countries, U.S. and Japan. Households in both countries need to hold cash in advance to purchase consumption goods: The U.S. dollar can be used to purchase both countries' goods, while the Japanese yen can only be used to purchase Japan's goods. Under these constraints, an expansionary U.S. monetary policy leads to (1) a larger U.S. trade deficit, (2) larger foreign holdings of the U.S. dollar, and (3) an appreciation of the U.S. real exchange rate. In contrast, the Japanese monetary policy has none of these real effects. Beyond asymmetric monetary effects, our novel mechanism also explains the correlation between consumption and real exchange rate, and the connection between foreign economic growth and the demand for the U.S. dollar.