TY  - JOUR
AU  - Bacchetta,Philippe
AU  - Wincoop,Eric van
TI  - A Theory of the Currency Denomination of International Trade
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 9039
PY  - 2002
Y2  - July 2002
UR  - http://www.nber.org/papers/w9039
L1  - http://www.nber.org/papers/w9039.pdf
N1  - Author contact info:
Philippe Bacchetta
Faculty of Business and Economics
University of Lausanne
Extranef
CH-1015 Lausanne
Switzerland
E-Mail: philippe.bacchetta@unil.ch

Eric van Wincoop
Department of Economics
University of Virginia
P.O. Box 400182
Charlottesville, VA  22904-4182
Tel: 434/924-3997
Fax: 434/982-2904
E-Mail: vanwincoop@virginia.edu
AB  - 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.
ER  -