What Drives Global Reserve Currency Dominance?

Hundreds of countries issue their own currencies, but just a few of those currencies dominate international trade and finance. To issue one of these “global reserve currencies,” a country must have a sufficiently large economy and a well-developed financial market. In the colonial era, the global reserve currencies were the Spanish dollar, the French franc, and the Dutch guilder. In the 19th century, these three currencies were supplanted by the British pound sterling. But then, at the pivotal 1944 Bretton Woods conference, a new international monetary management system was adopted, paving the way for the U.S. dollar to become the primary global reserve currency.¹

The U.S. dollar remains the primary global reserve currency, although other reserve currencies circulate as well. As of July 2025, the dollar had a roughly 58 percent share of all foreign exchange reserves, whereas the euro held a roughly 20 percent share and the Japanese yen and the pound sterling each had about a 5 percent share.²

A country reaps significant benefits from issuing a global reserve currency. It can borrow money more easily, its economy is able to sustain a persistent trade deficit (that is, it can import more than it exports), and its reserve currency status is a source of global political influence.³

For their paper, “International Currency Dominance,” Philadelphia Fed economists Joseph Abadi and Daniel Sanches and Philadelphia Fed Visiting Scholar Jesús Fernández-Villaverde of the University of Pennsylvania, the National Bureau of Economic Research, and the Centre for Economic Policy Research created a model to examine how countries’ macroeconomic conditions and government policies shape the international circulation of currencies. They studied the factors that lead to currency dominance and the rise of either a single reserve currency or multiple reserve currencies. They also examined policies a country might undertake to “internationalize” its own currency.

Their benchmark monetary (“New Monetarist”) model of the world economy consists of two countries that issue their own currencies for use as a medium of exchange for domestic and international transactions. Both countries have a “home bias”: In each country, people prefer to transact business in their home currency for legal reasons (that is, local tender laws) and ease of use. Using their model, the authors explored three types of international monetary regimes: unipolar dominance (one reserve currency), multipolarity (multiple reserve currencies), and autarky (no reserve currency). They also extended their model to add in the greater complexity of the international monetary system. In one case, they explored what happens when one large economy issues a dominant currency alongside a continuum of countries with smaller economies. This case resembles the role of the U.S. dollar as a vehicle currency, wherein some countries with smaller economies use dollars to trade with one another.

The authors find that, for a country to position its currency as the dominant global reserve currency, it must have a large economy with credible macroeconomic and fiscal policies and sufficient liquidity to meet the global demand for its currency. If this country loses its fiscal capacity to absorb the global demand for liquid assets, it could lose its currency dominance. The authors were able to replicate this predicament — which economists call the “Triffin dilemma”⁴ — in their model. “Only a large enough economy can play this role,” they find, “and if its growth does not keep pace with the global economy’s, its hegemonic [dominant] status will eventually fade.” Indeed, if no one country can absorb the demand for liquid assets alone, buyers will seek out other ways to meet their liquidity needs, which enables the rise of multiple international currencies.

A country that has a large enough economy and adequate fiscal resources may be able to strategically compete to make its currency a reserve currency by offering an attractive real rate of interest (that is, a rate adjusted for inflation) on the government bonds it issues.⁵ “Once a government’s real rate target is high enough,” the authors write, “its debt is guaranteed to circulate internationally.” How far a country can raise its bond rates, however, is limited by its fiscal capacity. For instance, a country may be unable to generate enough funds through taxation to cover the interest payments on the bond debt it issues.

This paper reveals a number of other insights, including that a country with a large enough economy can internationalize its currency without having to raise its bonds' interest rate as much as would a country with a smaller economy. And by raising the interest rate on its debt, a country may strategically block another country from trying to internationalize its currency.

Also, a country’s currency dominance may dissipate over time if the global economy becomes more integrated through, for example, the expanded use of digital payments or trade agreements. Greater integration, the authors show, favors the trading of multiple currencies rather than a single dominant currency.

How a currency reserve hierarchy forms and changes can have important implications for global efficiency and welfare. In their paper, Abadi, Sanches, and Fernández-Villaverde offer a framework for the study of how different currencies emerge as dominant and how policy shapes these outcomes. Their results offer insights into the future of the U.S. dollar as a primary global reserve currency and the potential for other reserve currencies to expand their influence.