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Trade, finance and international currency

Author

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  • Liu, Tao
  • Lu, Dong
  • Woo, Wing Thye

Abstract

Currency choices in international trade are related to the depth of financial markets, especially in the provision of trade finance. This paper examines: (i) how this financial channel affects international currency choices and (ii) the corresponding macroeconomic implications. Based on unique data with global coverage, we first document the empirical patterns of international currency usage and emphasize the importance of financial market development identifying the distinct trade finance channel. We then build a two-country monetary search model featuring time-to-ship friction and trade finance arrangements: goods are delivered one period after the contract, and the lack of commitment between exporters and importers forces the two parties to rely on bank-intermediated trade finance. The currency choice is endogenized and related to financial efficiency, terms of trade, and the inflation rate. We find that a country issuing a single international currency will: (i) enjoy incumbency advantage but have less room when implementing monetary policy; (ii) face a hump-shaped relationship between its economy size and optimal inflation level; and (iii) experience a persistent deficit in international trade. These results are illustrated with numerical examples and have rich implications for the current international monetary system dominated by the U.S. dollar.

Suggested Citation

  • Liu, Tao & Lu, Dong & Woo, Wing Thye, 2019. "Trade, finance and international currency," Journal of Economic Behavior & Organization, Elsevier, vol. 164(C), pages 374-413.
  • Handle: RePEc:eee:jeborg:v:164:y:2019:i:c:p:374-413
    DOI: 10.1016/j.jebo.2019.06.004
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    More about this item

    Keywords

    Trade finance; Financial development; Monetary search; International currency;

    JEL classification:

    • E40 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - General
    • E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General
    • F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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