A Theory of the Currency Denomination of International Trade

Philippe Bacchetta and Eric van Wincoop

No 9039, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: 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.

JEL-codes: F4 (search for similar items in EconPapers)
Date: 2002-07
New Economics Papers: this item is included in nep-dge and nep-ifn
Note: IFM ITI
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Citations: View citations in EconPapers (44)

Published as Bacchetta, Philippe and Eric van Wincoop. "A Theory Of The Currency Denomination Of International Trade," Journal of International Economics, 2005, 67(2,Dec), 295-319

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Journal Article: A theory of the currency denomination of international trade (2005)
Working Paper: A Theory of Currency Denomination of International Trade (2002)
Working Paper: A theory of the currency denomination of international trade (2002)
Working Paper: A Theory of the Currency Denomination of International Trade (2001)
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