Exorbitant Privilege

Exorbitant privilege is the special economic advantage enjoyed by a country whose currency serves as the world's dominant reserve and transaction currency. Because foreigners willingly hold assets denominated in that currency, the issuer can obtain goods, services and foreign assets by creating liabilities in its own currency on unusually favourable terms. The expression is most commonly associated with the international role of the US dollar.

How the privilege arises

Central banks, firms and investors demand the dominant currency for reserves, trade settlement and international finance. This demand is reinforced by network effects and by access to large markets for safe and liquid assets denominated in that currency.

Principal advantages

• The issuer can finance fiscal and external deficits more easily because foreign investors willingly hold its currency and government securities.
• It can generally borrow internationally at lower interest rates and in its own currency, reducing exchange-rate risk on its liabilities.
• It earns seigniorage when foreigners hold its currency, which is a non-interest-bearing liability exchanged for real goods, services or assets.
• Its residents face lower conversion, transaction and hedging costs because much international trade and finance is conducted in their domestic currency.

Limits and systemic costs

The privilege is not unlimited. It depends on confidence in the issuer's macroeconomic stability, institutions and financial markets.

• The issuer must supply enough reserve assets and liquidity to meet global demand, while excessive liability creation may weaken confidence. This tension is called the Triffin dilemma.
• Strong foreign demand can place upward pressure on the currency and reduce the competitiveness of domestic producers.
• Policies of the reserve-currency issuer create large global spillovers through interest rates, capital flows, debt-servicing costs and exchange rates.