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On the determinants of exporters' currency pricing: History vs. expectations

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  • Fukuda, Shin-ichi
  • Ono, Masanori

Abstract

The purpose of this paper is to investigate why the choice of invoice currency under exchange rate uncertainty depends not only on expectations but also on history. The analysis is motivated by the fact that the U.S. dollar has historically been the dominant vehicle currency in developing countries. The theoretical analysis is based on an open economy model of monopolistic competition. When the market is competitive enough, the exporting firms tend to set their prices not to deviate from those of the competitors. As a result, a coordination failure can lead the third currency to be a less efficient equilibrium invoice currency. The role of expectations is important in selecting the equilibrium in the static framework. However, in the dynamic model with staggered price-setting, the role of history becomes another key determinant of the equilibrium currency pricing. The role of history may dominate the role of expectations when the firms are myopic, particularly in the competitive local market. It also becomes dominant in the staggered price setting when a small fraction of the new price setters are backward-looking. The result suggests the importance of history in explaining why the firm tends to choose the US dollar as vehicle currency.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of the Japanese and International Economies.

Volume (Year): 20 (2006)
Issue (Month): 4 (December)
Pages: 548-568

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Handle: RePEc:eee:jjieco:v:20:y:2006:i:4:p:548-568

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Web page: http://www.elsevier.com/locate/inca/622903

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References

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  1. Shabtai Donnenfeld & Alfred Haug, 2003. "Currency Invoicing in International Trade: an Empirical Investigation," Review of International Economics, Wiley Blackwell, vol. 11(2), pages 332-345, 05.
  2. Wei, S.J. & Frankel, J.A., 1992. "Yen Bloc or Dollar Bloc: Exchange Rate Policies of the East Asian Economies," Papers 92-08, University of Birmingham - International Financial Group.
  3. V. V. Chari & Patrick J. Kehoe & Ellen R. McGrattan, 1996. "Sticky Price Models of the Business Cycle: Can the Contract Multiplier Solve the Persistence Problem?," NBER Working Papers 5809, National Bureau of Economic Research, Inc.
  4. Shin-ichi Fukuda, 1995. "The Structural Determinants of Invoice Currencies in Japan: The Case of Foreign Trades with East Asian Countries," Discussion Paper Series a307, Institute of Economic Research, Hitotsubashi University.
  5. Rey, Hélène, 1999. "International Trade and Currency Exchange," CEPR Discussion Papers 2226, C.E.P.R. Discussion Papers.
  6. Krugman, Paul, 1980. "Vehicle Currencies and the Structure of International Exchange," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 12(3), pages 513-26, August.
  7. Magee, Stephen P & Rao, Ramesh K S, 1980. "Vehicle and Nonvehicle Currencies in International Trade," American Economic Review, American Economic Association, vol. 70(2), pages 368-73, May.
  8. Michael B. Devereux & Charles Engel & Peter E. Storgaard, 2002. "Endogenous Exchange Rate Pass-Through When Nominal Prices are Set in Advance," Working Papers 212002, Hong Kong Institute for Monetary Research.
  9. Bacchetta, Philippe & Van Wincoop, Eric, 2002. "A theory of the currency denomination of international trade," Working Paper Series 0177, European Central Bank.
  10. Linda S. Goldberg & Cedric Tille, 2005. "Vehicle Currency Use in International Trade," NBER Working Papers 11127, National Bureau of Economic Research, Inc.
  11. Frankel, Jeffrey & Parsley, David & Wei, Shang-Jin, 2005. "Slow Passthrough Around the World: A New Import for Developing Countries?," Working Paper Series rwp05-016, Harvard University, John F. Kennedy School of Government.
  12. Friberg, Richard, 1998. "In which currency should exporters set their prices?," Journal of International Economics, Elsevier, vol. 45(1), pages 59-76, June.
  13. Baron, David P, 1976. "Fluctuating Exchange Rates and the Pricing of Exports," Economic Inquiry, Western Economic Association International, vol. 14(3), pages 425-38, September.
  14. repec:nbr:nberre:0126 is not listed on IDEAS
  15. Krugman, Paul, 1991. "History versus Expectations," The Quarterly Journal of Economics, MIT Press, vol. 106(2), pages 651-67, May.
  16. Michael B. Devereux & Charles Engel, 2001. "Endogenous Currency of Price Setting in a Dynamic Open Economy Model," NBER Working Papers 8559, National Bureau of Economic Research, Inc.
  17. McKinnon, Ronald I., 1979. "Money in International Exchange: The Convertible Currency System," OUP Catalogue, Oxford University Press, number 9780195024098.
  18. Taylor, John B, 1980. "Aggregate Dynamics and Staggered Contracts," Journal of Political Economy, University of Chicago Press, vol. 88(1), pages 1-23, February.
  19. Giovannini, Alberto, 1988. "Exchange rates and traded goods prices," Journal of International Economics, Elsevier, vol. 24(1-2), pages 45-68, February.
  20. Taylor, John B., 2000. "Low inflation, pass-through, and the pricing power of firms," European Economic Review, Elsevier, vol. 44(7), pages 1389-1408, June.
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Citations

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Cited by:
  1. Anand Sinha, 2012. "Financial Sector Regulation and Implications for Growth," BIS Papers chapters, in: Bank for International Settlements (ed.), Financial sector regulation for growth, equity and stability, volume 62, pages 45-84 Bank for International Settlements.
  2. Straume, Hans-Martin, 2013. "Currency invoicing in Norwegian salmon export," Working Papers in Economics 11/13, University of Bergen, Department of Economics.
  3. Terada-Hagiwara, Akiko, 2011. "Asian holding of US Treasury securities: Trade integration as a threshold," Journal of the Japanese and International Economies, Elsevier, vol. 25(3), pages 321-335, September.
  4. Xiangyun Xu & Peng Guo, 2012. "Exchange rate appreciation expectation, importer's behavior and choice of invoicing currency: A theoretical model and Yen's empirical evidence," China Finance Review International, Emerald Group Publishing, vol. 2(3), pages 231-245, June.
  5. Shinji Takagi, 2011. "Internationalising the yen, 1984-2003: unfinished agenda or mission impossible?," BIS Papers chapters, in: Bank for International Settlements (ed.), Currency internationalisation: lessons from the global financial crisis and prospects for the future in Asia and the Pacific, volume 61, pages 75-92 Bank for International Settlements.

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