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Create account Login Subscribe. In international macroeconomics, it is typically assumed that the exchange rate between two trading partners matters most for trade prices, quantities, and terms of trade. This is because invoicing in dollars is common, even when the US is not part of a transaction.
The findings have important implications for the conduct of monetary and exchange rate policies. Leading paradigms in international macroeconomics connect the movements of the exchange rate that prevails between trading partners to the changes in their terms of trade.
This insight is also a central prediction of the canonical Mundell-Fleming paradigm Mundell , Fleming , Obstfeld and Rogoff which assumes that a nominal exchange rate depreciation is associated with a deterioration of a country's terms of trade i.
In other words, the ratio of the price of its imports to that of its exports increases when the nominal exchange rate depreciates. An opposing influential paradigm Betts and Devereux , Devereux and Engel assumes pricing in the local or destination currency and has at its core the opposite prediction — a nominal exchange rate depreciation is associated with an improvement of a country's terms of trade.
Globally, these paradigms imply that a country's exchange rate is only as important as its share in world trade, with no exchange rate playing a disproportionate role. Accordingly, Casas et al.
The evidence they provide using Colombian micro data lends strong support to these predictions. To gauge the global relevance of the three pricing paradigms, in a new study we construct harmonised annual bilateral import and export unit value and volume indices for a globally representative sample Boz et al. Our indices are for 55 countries, yielding more than 2, dyads i. Importantly, we exclude commodities from these indices because the paradigms are relevant only for goods with sticky prices.
We find that neither the producer nor the local currency pricing paradigm fits the observed patterns in global trade, but the data rather support the dominant currency paradigm.
This happens regardless of whether the US is part of the trade transaction. Invoicing of trade in dollars is an important part of the explanation. The finding stands in sharp contrast to the predictions of the leading benchmark paradigms. It is, however, fully consistent with the dominant currency paradigm — with most imports and exports invoiced in dollars, the terms of trade of a country are disconnected from its exchange rate.
We next estimate the pass-through of bilateral exchange rates into import prices and volumes at the country pair level. This suggests an almost complete pass-through at the one year horizon. However, adding in the exchange rate of the importer relative to the dollar dramatically reduces the impact of the bilateral exchange rate from 0. Instead, the dollar exchange rate becomes the dominant factor with an impact of 0. Figure plots the impulse responses of bilateral price level to bilateral and US dollar exchange rates, estimated using importer reported data.
Left column estimates are from a standard specification where bilateral import price changes are regressed on bilateral exchange rate changes. Right column adds the importer versus US dollar exchange rate as an explanatory variable. Additionally, the role of the dollar fluctuations is larger for countries that invoice more in dollars.
Similarly, adding the dollar exchange rate to a bilateral volume forecasting regression knocks down the coefficient on the bilateral exchange rate by a substantial amount.
The contemporaneous volume elasticity for the dollar exchange rate is We also find that the dollar's role as an invoicing currency is indeed special as it handily beats the explanatory power of the euro in price and volume regressions. Furthermore, countries with larger dollar import invoicing shares experience higher pass-through of the dollar exchange rate into consumer and producer price inflation. While these findings are puzzling from the perspective of the traditional Mundell-Fleming model due to its emphasis on bilateral exchange rates, they emerge naturally under the dominant currency paradigm.
We next build a flexible hierarchical Bayesian framework to see what fraction of cross-dyad heterogeneity in pass-through coefficients is explained by the propensity to invoice imports in dollars. We also find that the importer's dollar invoicing share affects the exchange rate elasticity of trade volumes.
These findings confirm the quantitative importance of the global currency of invoicing, a key concept in the dominant currency paradigm. Our findings reveal that the terms of trade are only weakly sensitive to the exchange rate, the value of a country's currency relative to the dollar is a primary driver of a country's import prices and quantities regardless of where the good originates from, and the prevalence of dollar invoicing is an important predictor of the sensitivity of price and quantities to the dollar exchange rate.
Given the magnitudes of our estimates and the global coverage of our data, the dominant currency paradigm is a more empirically relevant benchmark than the traditional modelling approaches when analysing the international transmission of shocks, and optimal monetary and exchange rate policy. Exchange rates International trade. Global trade and the dollar Emine Boz, Gita Gopinath, Mikkel Plagborg-Moller 11 February In international macroeconomics, it is typically assumed that the exchange rate between two trading partners matters most for trade prices, quantities, and terms of trade.
Revisiting international currency competition. The illusion of monetary policy independence under flexible exchange rates. Is there room for more than one international currency? When did the dollar overtake sterling as the leading international currency? Evidence from the bond markets. Below we elaborate more on four key facts that lead to our conclusions. Changes in the dollar exchange rate dominate changes in the bilateral exchange rates between trading partners in accounting for import price and quantity movements We next estimate the pass-through of bilateral exchange rates into import prices and volumes at the country pair level.
Conclusion Our findings reveal that the terms of trade are only weakly sensitive to the exchange rate, the value of a country's currency relative to the dollar is a primary driver of a country's import prices and quantities regardless of where the good originates from, and the prevalence of dollar invoicing is an important predictor of the sensitivity of price and quantities to the dollar exchange rate.
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