Banking Crises, Nonlinear Export Elasticities, and the Dominant Currency Paradigm

The dominant currency paradigm posits that dollar invoicing reduces the potency of exchange rate depreciations in boosting export volumes. This implies that export elasticities with respect to the exchange rate are small, rendering even large depreciations ineffectual in the short term. We incorporate two innovations versus existing work. First, we allow for nonlinearities, permitting large depreciations to disproportionately lift exports. Second, we control for banking crises, which accompany many depreciations. Our baseline export elasticity—without nonlinearities or banking crisis controls—is -0.3, consistent with prevailing “elasticity pessimism.” This elasticity rises to between -0.5 and -0.8 within two years for depreciations above 20 percent without banking crises.