[CHAIR WORKING PAPERS #1] Should Europe continue to fund U.S. Federal Debt?

Abstract:

Against a backdrop of heightened international trade tensions and a possible decoupling of
leading economies it may be time to examine the economic validity of countries maintaining
large foreign exchange reserves denominated in the US dollar. Specifically, in this paper we
assess to what extent Europe should follow in the footsteps of China to trim its US dollar
reserves invested in US Federal debt. Using a three-country dynamic general equilibrium
model built around stylized representations of the United States, the euro area and China,
we find that a cutback of foreign investments in US federal debt would make economic
sense, but that a collapse of the dollar’s dominant position within the international monetary
system is unlikely, unless China prioritises geo-strategic goals over economic rationales.

Read the working paper by Paola Subacchi and Paul van den Noord.