Why does the effect of trade policy on the monetary order matter?

Tarek A. Hassan and his coauthors ask how different configurations of trade and financial policy, notably tariffs, trade blocks, and capital controls, reshape the international monetary order: which currencies act as global “safe” assets and which become the preferred anchor currency for smaller economies. This question is timely because recent tariff increases among major economies (notably the U.S. in 2025) coincided with unusual movements in exchange rates, interest rates, and asset prices that opened the discussion about the conventional view of a single uncontested safe currency (the U.S. dollar). The paper therefore probes whether a country’s international role as a provider of financial insurance depends not only on its economic size but also on its openness to global trade. The policy relevance is large: shifts in anchor status change sovereign borrowing costs, capital accumulation, and welfare across countries, with direct fiscal consequences measured in the hundreds of billions of dollars in some calibrations.

How size and openness interact

A central mechanism is the concept of an economy’s effective size: tariffs reduce how strongly a country’s domestic shocks affect global traded‑goods scarcity, so protective trade policy shrinks a country’s effective footprint in international financial markets and erodes its currency’s safety premium. Under free trade, the largest economy’s currency tends to appreciate in global “bad times,” making it the safest currency; isolating a large country with tariffs restricts inflows in times of crisis and raises its interest rates. The model yields a robust and simple rule: across many coalitional configurations, the largest economy that remains most deeply integrated with the global trading network retains the largest safety premium and attracts the most stabilizers. Thus, anchor identity is not determined by size alone but by the interaction of size and openness.

Configurations of trade barriers and implications for currencies

Applying the mechanism to three policy levers facing Europe, evaluated within a standard international finance model, produces several concrete outcomes. First, deepening economic integration across EU members can strengthen the role and global attractiveness of the euro. In our model, the tariff threshold for the euro to become the anchor currency falls significantly if the eurozone were to deepen its integration. Second, the analysis suggests potentially high returns from trade openness in terms of lower borrowing rates as well as safer and more attractive currencies. Third, capital-account openness leads to similar effects as trade openness. We show formally in our model that severe capital controls lower the effective size of an economy. Across these three levers, a clear pattern emerges: the economy that maintains the deepest ties to global trade and financial markets minimizes its currency risk, maximizes its capital stock, and attracts the world’s exchange-rate stabilizers.

What data and which methods were applied?

The study uses a calibrated, multi-country general-equilibrium model of the international monetary system that embeds financial market segmentation and allows currency safety to arise endogenously from how domestic shocks spill over into world prices. The model is calibrated to

match key international asset- and exchange-rate moments and uses GDP shares (2023 values) for the U.S., EU (Euro Area), China, and many smaller economies; it also validates predicted exchange-rate arrangements against observed data (Ilzetzki, Reinhart, and Rogoff, 2019). The authors simulate four stylized tariff and capital control scenarios, and they translate model-implied interest-rate changes into fiscal effects using actual 2025 government debt stocks. Where relevant, the model assumes symmetric retaliation to simplify interpretation; it also considers limits such as China’s historical capital‑account restrictions unless explicitly relaxed in a scenario.

What policymakers can take from this

The key policy takeaway is that trade and financial policy decisions have large and perhaps underappreciated monetary and fiscal side‑effects. By reducing trade openness, a large economy may forfeit a safety premium that lowers its borrowing costs and supports higher capital accumulation; the authors show these effects can translate into hundreds of billions of dollars in higher annual interest payments for the issuer that loses safe haven privileges. For smaller economies, the choice of which currency to stabilize against depends on which large economy remains most open; thus national exchange‑rate strategies interact with global trade and financial policy. The paper also highlights avenues for strategic response: deepening EU integration or enlargement can raise a currency’s effective size and lower the protectionism threshold required for becoming an anchor currency. Finally, the findings argue for treating trade, monetary, and fiscal policy as interconnected: protectionist moves intended to shield domestic industries can produce substantial macro‑financial tradeoffs that extend well beyond standard trade‑diversion effects.

Openness, Integration, and the International Monetary Order

Authors:

Tarek A. Hassan (Boston University)

Thomas M. Mertens (Federal Reserve Bank of San Francisco)

Jingye Wang (Renmin University of China)

Tony Zhang (Arizona State University, W.P. Carey School of Business)

(paper presented at the 2nd Economic Policy: Papers on European and Global Issues Conference)