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Currency choice in international trade: a new monetarist approach and firm-level evidence

Liu, Tao and Lu, Dong and Zhang, Ruifeng (2017): Currency choice in international trade: a new monetarist approach and firm-level evidence.

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Abstract

Financial market imperfections severely restrict currency use in international trade. We develop a unified search-based framework with financial frictions to address the determinants for currency, emphasizing the roles of trade finance and financial market development, as well as macro, micro factors and firm-level bargaining power. In an open economy monetary search model with financial intermediation, the usage of a particular currency will emerge endogenously and strategic complementarities among exporters, importers, and financial intermediation reinforce the status of international currency. With highly disaggregated data from Colombia, we provide firm-level evidence that financial factors significantly affect the patterns of currency usage. We show that exporters prefer the currency with a more developed financial market, especially for small firms in financially vulnerable sectors. In particular, a developing country with medium-level of financial development could enhance its currency usage by more than 10% if they further develop their financial market. Meanwhile, bad monetary policy and low bargaining power of exporters will hurt the popularity of currency, although empirically firm-level bargaining power only has a secondary effect. These results provide important policy implications for developing countries that seek to improve the international role of its own currency but suffer from financial market underdevelopment, unstable monetary policy, and inferior bargaining positions of firms, emphasizing the role of finaical market development and macroeconomic stability.

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