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Message from ADB's President Contributors Acknowledgements Executive Summary and Recommendations Jeffrey D. Sachs, Masahiro Kawai, Jong-Wha Lee, and Wing Thye Woo Paper Summaries (full papers downloadable) International Monetary Advisory Group Global Financial Crisis, its Impact on India and the Policy Response Nirupam Bajpai To What Extent Should Capital Flows be Regulated? Maria Socorro Gochoco-Bautista The Case for a Further Global Coordinated Fiscal Stimulus Willem Buiter Managing a Multiple Reserve Currency World Barry Eichengreen From the Chiang Mai Initiative to an Asian Monetary Fund Masahiro Kawai An Asian Currency Unit for Asian Monetary Integration Masahiro Kawai The International Monetary System at a Crossroad Felipe Larrain B. Towards a New Global Reserve System Joseph Stiglitz A Realistic Vision of Asian Economic Integration Wing Thye Woo An Asian Monetary Unit? Charles Wyplosz Will US fiscal Deficits Undermine the Role of the Dollar as Global Reserve Currency? If So, Should US Fiscal Policy be geared to Preserving the International Role of the Dollar? Yongding Yu International Monetary Working Group International Reserves and Swap Lines: the Recent Experience Joshua Aizenman, Donghyun Park and Yothin Jinjarak The Future of the Global Reserve System Daniel Gros, Cinzia Alcidi, Anton Brender, and Florence Pisani Renminbi Policy and the Global Currency System Yiping Huang Will the Renminbi Emerge as an International Reserve Currency? Jong-Wha Lee Asia's Sovereign Wealth Funds and Reform of the Global Reserve System Donghyun Park and Andrew Rozanov Reforming International Monetary System Kanhaiya Singh Designing a Regional Surveillance Mechanism for East Asia: Lessons from IMF Surveillance Shinji Takagi

11. Will US fiscal Deficits Undermine the Role of the Dollar as Global Reserve Currency? If So, Should US Fiscal Policy be geared to Preserving the International Role of the Dollar?

Yongding Yu

Any international monetary system has to perform two basic functions: providing liquidity for international transactions and facilitating the adjustment of current account imbalances. Since the end of the Second World War, the dollar has been used as the single most important medium of exchange, shore of value and unit of account in the international transactions. In other words, the dollar has played the role of the global reserve currency. However, the use of national fiat money as global reserve currency inevitably causes confident problem. As a result of persistent current account deficits, US net international investment position (NIIP) - to- GDP ratio has been increasing steadily over the decades. The doubt about US’ ability of honoring its debt obligation has been increasing significantly since the turn of the century.

The recent global financial crisis and the policy responses by the US government towards the crisis and its aftermath have further shaken the confidence in the dollar. Among the policy responses, the dramatic increase in US fiscal deficit stands out as the most worrying aspect of US government policy. The increase in fiscal deficit and the consequent increase in the NIIP-to- GDP ratio inevitably will produce negative impacts on current account balance and hence will pose serious threat to the role of the dollar as global reserve currency. However, currently, the priority of US macroeconomic policy is to maintain the momentum of recovery. US fiscal policy should not be geared at preserving the role of the dollar as reserve currency. This is because dollar’s role as global reserve currency depends on a wider range of factors and the impact of the increase in fiscal deficit on the dollar can be limited in the short run. Furthermore, in the short-run, the negative impact of the increase in fiscal deficit on the dollar can be offset by other policies such as trade policy.