Working Paper: CEPR ID: DP3120
Authors: Philippe Bacchetta; Eric van Wincoop
Abstract: Nominal rigidities due to menu costs have become a standard element in closed economy macroeconomic modelling. 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.
Keywords: currency; invoicing; new open economy macroeconomics
JEL Codes: F31; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Market Share of the exporting country (F10) | Invoicing in the exporter’s currency (F31) |
| Degree of product differentiation (L15) | Invoicing in the exporter’s currency (F31) |
| Market Share (L17) | Passthrough elasticities for exporters (F14) |
| Invoicing decisions of other domestic firms (L14) | Firm’s choice of invoicing currency (F31) |
| Market Share of the exporting country (F10) | Pricing strategies of exporters (F14) |