NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Dominant Currency Paradigm

Camila Casas, Federico J. Díez, Gita Gopinath, Pierre-Olivier Gourinchas

NBER Working Paper No. 22943
Issued in December 2016
NBER Program(s):   EFG   IFM   ITI   ME

Most trade is invoiced in very few currencies. Despite this, the Mundell-Fleming benchmark and its variants focus on pricing in the producer's currency or in local currency. We model instead a ‘dominant currency paradigm’ for small open economies characterized by three features: pricing in a dominant currency; pricing complementarities, and imported input use in production. Under this paradigm: (a) terms of trade are stable; (b) dominant currency exchange rate pass-through into export and import prices is high regardless of destination or origin of goods; (c) exchange rate pass-through of non-dominant currencies is small; (d) expenditure switching occurs mostly via imports and export expansions following depreciations are weak. Using merged firm level and customs data from Colombia we document strong support for the dominant currency paradigm and reject the alternatives of producer currency and local currency pricing.

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Document Object Identifier (DOI): 10.3386/w22943

 
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