Dominant Currency Paradigm

TLDR

The authors introduce a dominant currency paradigm, outlining dominant currency pricing, pricing complementarities, and imported inputs in production, and aim to analyze how monetary policy shocks transmit and spill over within this framework. They test the paradigm using a comprehensive dataset of bilateral price and volume indices covering 91 % of world trade across more than 2,500 country pairs, supplemented by detailed firm‑product‑country data on Colombian exports and imports. Their results show that non‑commodity terms of trade are uncorrelated with exchange rates, the dollar exchange rate dominates bilateral rates in price pass‑through and trade elasticity—especially when imports are invoiced in dollars—US import volumes are less sensitive to bilateral rates than other countries, and a 1 % dollar appreciation predicts a 0.6 % decline in total trade volume among non‑US countries within a year, controlling for the global business cycle. JEL codes: E52, F14, F31, F44.

Abstract

We propose a “dominant currency paradigm” with three key features: dominant currency pricing, pricing complementarities, and imported inputs in production. We test this paradigm using a new dataset of bilateral price and volume indices for more than 2,500 country pairs that covers 91 percent of world trade, as well as detailed firm-product-country data for Colombian exports and imports. In strong support of the paradigm we find that (i) noncommodities terms-of-trade are uncorrelated with exchange rates; (ii) the dollar exchange rate quantitatively dominates the bilateral exchange rate in price pass-through and trade elasticity regressions, and this effect is increasing in the share of imports invoiced in dollars; (iii) US import volumes are significantly less sensitive to bilateral exchange rates, compared to other countries’ imports; (iv) a 1 percent US dollar appreciation against all other currencies predicts a 0.6 percent decline within a year in the volume of total trade between countries in the rest of the world, controlling for the global business cycle. We characterize the transmission of, and spillovers from, monetary policy shocks in this environment. (JEL E52, F14, F31, F44)