Vehicle currency pricing and its positive welfare consequences under optimal monetary policy

Using a two-country general equilibrium model, this paper analytically derives the possibility of positive welfare consequences of vehicle currency use in invoicing international trades. Such vehicle currency use is prominent in the data. The literature points out welfare loss under optimal monetary policy due to vehicle currency pricing relative to the flexible price equilibrium outcome, modeling only tradable goods. By introducing nontradable goods and their sector-specific productivity shocks, this paper provides a closed-form condition under which one country’s welfare is higher under optimal monetary policy if its exports are invoiced with the other country’s currency than if invoiced with its own currency, given that the other country’s exports are invoiced with the producer’s currency. That is, this paper derives a condition under which vehicle currency pricing is preferred by the nonvehicle currency country to producer currency pricing. 2014 Elsevier B.V. All rights reserved. § For helpful comments and suggestions, I thank two anonymous referees, Giancarlo Corsetti, Takatoshi Ito, Masahiro Kawai, Chu Ping Lo, Dominik Menno, and seminar participants at Academia Sinica, Feng Chia University, the Midwest Macro Meetings in Nashville, the Max Weber June Conference at the European University Institute, and the ASSA (CEANA-NTU-TEA session) in Chicago. The support received from the Max Weber Programme at the European University Institute and the National Science Council is gratefully acknowledged. * Tel.: þ886 2 2351 9641; fax: þ886 2 2351 1826. E-mail address: [email protected] 1 For a comprehensive survey, see Lane (2001), Bowman and Doyle (2003), Corsetti et al. (2010). 2 Under LCP, firms can conduct pricing to market. See Betts and Devereux (1996, 2000), among others.