Assessing global dollar liquidity stress: A novel index
Maylin H. Sun, in this paper, introduces a novel measure of dollar funding shortage, the “Dollar Funding Shortage” (DFS) index, which assesses country-level dollar funding conditions using natural language processing (NLP) techniques. The DFS index offers a new, country-level measure of dollar funding conditions, complementing existing indicators like the cross-currency basis.
Methodology
- Data source: The study uses over 32,000 global and local news articles, newswires, industry publications, magazines, and reports to gather information on dollar funding shortages.
- Data period: The dataset covers 116 economies from 1980 to 2021, providing a comprehensive view of dollar funding conditions across both developed and developing countries.
- Definition of dollar funding shortage: The author defines dollar shortage as country-wide dollar liquidity stress in the banking sector, focusing on funding illiquidity faced by financial institutions.
Findings
- Prevalence of dollar shortages: Severe dollar funding shortages are found to be more common than financial crises and often occur simultaneously with or precede currency and banking crises.
- Macroeconomic impact: Dollar shortages have significant adverse effects on GDP, bank dollar lending, imports, and exports, particularly in sectors heavily reliant on external finance.
- Industry-level effects: The exports of sectors more dependent on external finance grow significantly less during severe dollar funding shortages.
- Global resilience: The global financial system has become more resilient to dollar funding shocks since the Global Financial Crisis, partly due to regulatory changes and international cooperation.
Measuring Dollar Funding Shortage
Author: Maylin H. Sun
From: IMF
Reserve currency dynamics: dollar, euro, and beyond
Chinn, Frankel, and Ito in the paper, explore the determinants of foreign exchange reserve holdings by central banks, focusing on the US dollar and the euro.
Methodology
- Determinants of reserve holdings: The authors examine several factors influencing central banks’ decisions on reserve currency holdings. These include the size of the issuing country’s economy and financial markets, the currency’s ability to hold value, and inertia (the tendency to maintain existing practices).
- Individual central bank behavior: The study analyzes individual central bank behavior, incorporating bilateral trade relationships, currency pegs, and geopolitical factors like sanctions.
- Data analysis: The authors use both aggregate data and individual central bank data. Due to limitations in sample size and variation for individual currencies, they also pool data across major currencies to impose consistent determinants across all reserve currencies.
Findings
- Dollar dominance: Despite a gradual decline in its share of foreign exchange reserves since the turn of the century, the US dollar remains the dominant international reserve currency. Its dominance is supported by its extensive use in trade invoicing, international debt, and foreign exchange turnover.
- Euro’s decline: The euro, initially seen as a potential challenger to the dollar, has lost momentum due to the European sovereign debt crisis and the UK’s decision not to join the eurozone.
- Renminbi’s rise and fall: China’s renminbi was once considered a rising star, but its growth has slowed, and capital controls have limited its internationalization.
- Geopolitical factors: Geopolitical variables, such as sanctions, have not significantly impacted reserve holdings in the models. However, they have led some countries to diversify away from the dollar.
- Determinants of reserve holdings: Economic factors like GDP size and foreign exchange turnover are significant determinants of reserve holdings when data are pooled across currencies. However, geopolitical factors generally do not enter with significance in these models.
The Dollar versus the Euro as International Reserve Currencies
Authors: Menzie D. Chinn, Jeffrey A. Frankel, Hiro Ito
From: University of Wisconsin, Harvard University, Portland State University
