Mapping Out Emerging Network Structures in Dynamic Network Models Coupled with Epidemics

Abstract

We are grateful to Chris Anderson and Taehoon Kim for outstanding research assistance. In recent work (Gopinath and Stein (2017)) we explore how a currency like the dollar can become entrenched as a dominant global currency, focusing on the two-way feedback between trade invoicing and banking structure. The basic idea is that when a larger share of a country's imports are invoiced in dollars, its citizens have a greater demand for dollar-denominated safe claims. This in turn leads the local banking sector to become more dollarized, in the sense of funding itself more with dollar-denominated liabilities. Here we extend the framework of that paper to consider the implications for central-bank reserve holdings. We show that when a country's banks are more heavily dollar funded, this induces the central bank-in its role as lender of last resort-to hold a larger stockpile of dollar reserves. 1 We also provide some suggestive evidence which is consistent with this hypothesis. I. The Model We model the behavior of three sets of agents in a representative emerging-market country: households, banks, and the central bank. There are two dates, 0 and 1. The time-0 exchange rate 0 ε (in units of local currency per dollar) is normalized to 1. The time-1 exchange rate 1 ε is (1+z) with probability p = 0.5, and is (1-z) with probability (1-p) = 0.5. The parameter z is thus a proxy for the volatility of the exchange rate. In the event that 1 (1) z ε = + , i.e. that the local currency depreciates against the dollar, there is a probability q of a banking crisis which requires the central bank to bail out a fraction of the banking sector. Thus banking crises are correlated with a weaker domestic currency; this is a key assumption of the model. 1 Other papers that analyze central-bank reserve holdings from the perspective of a lender of last resort include Obstfeld, Shambaugh and Taylor (2010) and Bocola and Lorenzoni (2017).