A two-pronged approach to currency internationalization

Policies aimed at promoting currency internationalization often target frictions in both capital and current account transactions. We study this two-pronged approach using a dynamic general equilibrium model in which an international currency serves as both a store of value and a medium of exchange. Due to the complementarity between different functions of an international currency, a two-pronged approach is more effective than policies with a single focus. We analytically characterize this policy complementarity and apply the model to China’s renminbi internationalization reforms during 2010-2021. We find that: (1) These reforms reduced the return wedge on foreign held renminbi bonds by 4.1 percentage points (p.p.) and lowered the cost of renminbi-settled international trade by 0.9 p.p. in trade-revenue equivalent. (2) Policy complementarity accounted for half of the overall policy effect. (3) A single-focused policy — targeting only capital (current) account frictions — would have raised fiscal costs by a factor of 2.1 (1.8).