Dominant Currencies and External Adjustment

Abstract

The extensive use of the US dollar when firms set prices for international trade (dubbed dominant currency pricing) and in their funding (dominant currency financing) has come to the forefront of policy debate, raising questions about how exchange rates work and the benefits of exchange rate flexibility. This Staff Discussion Note documents these features of international trade and finance and explores their implications for how exchange rates can help external rebalancing and buffer macroeconomic shocks.

A Gathering of Storms: The Impact of COVID-19 Pandemic on the Balance of Payments of Emerging Markets and Developing Economies (EMDEs)

“…This means that domestic conditions of competitiveness captured by the real exchange rate do not impact the performance of export and import volumes, at least in the short run. This is compatible with the "dominant currency paradigm" of Gopinath (2016) and Adler et al (2020): Imports and exports are denominated in US dollars and, in the case of commodity exporters, their price is determined in external markets.…”

Argentina: Ex-Post Evaluation of Exceptional Access Under the 2018 Stand-By Arrangement-Press Release and Staff Report

“…This outcome is partly explained by the drought of 2018, which hit agricultural exports hard. Moreover, nonagricultural export volumes did not respond to the peso depreciation, reflecting pervasive dollar invoicing-more than 95 percent (85 percent) of Argentine exports (imports) are denominated in U.S. dollars (Boz et al 2020), implying limited expenditure switching effects of exchange rate movements on exports, but high pass-through to import prices (Adler et al 2020).1 4F 15…”

Toward an Integrated Policy Framework

“…Exchange rate depreciation in these countries is associated with a cutback in imports but no significant increase in exports in the short term. Similarly, Adler, Casas et al (2020) show that in countries whose corporates depend on dollar financing, a depreciation can lead to financial distress and a cutback in imports with no stimulative effect on exports. Overall, with dominant currency pricing and financing, the short-term response of trade volumes to exchange rates is likely to be more muted and manifested mostly through imports.…”

“…Most EMDEs price their exports in dollars, purchase imports priced in dollars, and borrow in dollars. Gopinath et al (2020) and Adler, Casas et al (2020) document that with dominant currency pricing a country's exchange rate vis-à-vis the dollar (not vis-à-vis its trading partners) is the major determinant of passthrough and traded volumes in the short term. Exchange rate depreciation in these countries is associated with a cutback in imports but no significant increase in exports in the short term.…”