A Theory of the Currency Denomination of International Trade

By Philippe Bacchetta, Eric van Wincoop. Social Science Research Network, 2002

377 citations recorded by the source corpus.

Nominal rigidities due to menu costs have become a standard element in closed economy macroeconomic modeling. The ''New Open Economy Macroeconomics'' literature has investigated the implications of nominal rigidities in an open economy context and found that the currency in which prices are set has significant implications for exchange rate pass-through to import prices, the level of trade and net capital flows, and optimal monetary and exchange rate policy. While the literature has exogenously assumed in which currencies goods are priced, in this paper we solve for the equilibrium optimal pricing strategies of firms. We find that the higher the market share of an exporting country in an industry, and the more differentiated its goods, the more likely its exporters will price in the exporter's currency. Country size and the cyclicality of real wages play a role as well, but are empirically less important. We also show that when a set of countries forms a monetary union, the new currency is likely to be used more extensively in trade than the sum of the currencies it replaces.

Subfields: Economics and Econometrics, Finance

View Paper: https://www.semanticscholar.org/paper/3ce9cdc7054995b1c26003dce4a9117cec005895

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Citations in the corpus

A macroeconomic model of international price discrimination (2005, background): “Recent work by Bacchetta and Van Wincoop (2002) , Corsetti and Pesenti (2002) and Devereux et al. (2004) analyzes the problem of producers who can choose whether to preset prices in domestic currency only or in both domestic and foreign currencies.”
Incomplete Pass-Through and the Welfare Effects of Exchange Rate Variability (2005, neutral): “CH = C H;1C (1¡Ã) H;2 ÃÃ(1¡ Ã)(1¡Ã) ; CF = C F;1C (1¡Ã) F;2 ÃÃ(1¡ Ã)(1¡Ã) (3)”
Endogenous Exchange Rate Pass-through when Nominal Prices are Set in Advance (2004, neutral): “Bacchetta and Van Wincoop (2002) focus on the choice of invoicing currency (or currency of price setting) in a static general equilibrium framework, providing analytical results.”
A corporate balance-sheet approach to currency crises (2001, background): “Combining (10), (11), and the fact that y3 = σ(1 + μ)w3, we obtain:”
Self-Validating Optimum Currency Areas (2002, neutral): “Home firms choose p̃t(h) one period in advance at time t−1 by maximizing (1) as above, while the actual pt (h) depends on the realization of the exchange rate at time t.”
Exchange Rate Pass-Through And Monetary Policy (2008, background): “…with nominal price rigidities implies that exchange rate fluctuations will have less impact on import prices, at least in the short run (Devereux and Engel, 2002; Bacchetta and van Wincoop, 2005; Campa and Goldberg, 2005; Gopinath, Itskhoki, and Rigobon, 2007; Gopinath and Rigobon, forthcoming).”
Exchange Rate Pass-Through in the Global Economy: The Role of Emerging Market Economies (2014, positive): “|Although a few papers have estimated equations for import prices in EMEs (Frankel, Parsley, and Wei, 2005; Barhoumi, 2006; Choudhri and Hakura, 2006; Ca’Zorzi, Hahn, and Sanchez, 2007), to our knowledge, no paper has done it also for export prices with the exception of Vigfusson, Sheets, and Gagnon”