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Trade, finance and international currency

Tao Liu, Dong Lu and Wing Thye Woo

Journal of Economic Behavior & Organization, 2019, vol. 164, issue C, 374-413

Abstract: Currency choices in international trade are related to the depth of financial markets, especially in the provision of trade finance. This paper examines: (i) how this financial channel affects international currency choices and (ii) the corresponding macroeconomic implications. Based on unique data with global coverage, we first document the empirical patterns of international currency usage and emphasize the importance of financial market development identifying the distinct trade finance channel. We then build a two-country monetary search model featuring time-to-ship friction and trade finance arrangements: goods are delivered one period after the contract, and the lack of commitment between exporters and importers forces the two parties to rely on bank-intermediated trade finance. The currency choice is endogenized and related to financial efficiency, terms of trade, and the inflation rate. We find that a country issuing a single international currency will: (i) enjoy incumbency advantage but have less room when implementing monetary policy; (ii) face a hump-shaped relationship between its economy size and optimal inflation level; and (iii) experience a persistent deficit in international trade. These results are illustrated with numerical examples and have rich implications for the current international monetary system dominated by the U.S. dollar.

Keywords: Trade finance; Financial development; Monetary search; International currency (search for similar items in EconPapers)
JEL-codes: E40 E50 F33 F41 (search for similar items in EconPapers)
Date: 2019
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jeborg:v:164:y:2019:i:c:p:374-413

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Journal of Economic Behavior & Organization is currently edited by Houser, D. and Puzzello, D.

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