Endogenous Currency of Price Setting in a Dynamic Open Economy Model / Michael B. Devereux, Charles Engel.

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Devereux, Michael B

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Material type: Text

TextSeries: Working Paper Series (National Bureau of Economic Research) ; no. w8559.Publication details: Cambridge, Mass. National Bureau of Economic Research 2001.Description: 1 online resource: illustrations (black and white)Subject(s):

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Abstract: Many papers in the recent literature in open economy macroeconomics make different assumptions about the currency in which firms set their export prices when nominal prices must be pre-set. But to date, all of these studies take the currency of price setting as exogenous. This paper sets up a simple two-country general equilibrium model in which exporting firms can choose the currency in which they set prices for sales to foreign markets. We make two alternative assumptions about the structure of international financial markets: one where there are complete markets for hedging consumption risk internationally, and the other without risk-sharing possibilities. Our results are quite sharp: exporters will generally wish to set prices in the currency of the country that has the most stable monetary policy. When monetary stability is similar among countries, there is an equilibrium where firms from all countries set their price in the currency of the buyer (local currency pricing). But except for a special case where money variances are exactly identical across countries, there is no equilibrium where all firms set export prices in their own currencies (producer currency pricing).

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Previous	nber w8556 Changes in the Age Distribution of Mortality Over the 20th Century /	nber w8557 The Market for Crash Risk /	nber w8558 Real Exchange Rate Fluctuations and the Dynamics of Retail Trade Industries on the U.S.-Canada Border /	nber w8559 Endogenous Currency of Price Setting in a Dynamic Open Economy Model /	nber w8560 Migration Consequences of Welfare Reform /	nber w8561 Population Aging, Savings Behavior and Capital Markets /	nber w8562 Alcohol Taxes and Labor Market Outcomes /	Next

October 2001.

Many papers in the recent literature in open economy macroeconomics make different assumptions about the currency in which firms set their export prices when nominal prices must be pre-set. But to date, all of these studies take the currency of price setting as exogenous. This paper sets up a simple two-country general equilibrium model in which exporting firms can choose the currency in which they set prices for sales to foreign markets. We make two alternative assumptions about the structure of international financial markets: one where there are complete markets for hedging consumption risk internationally, and the other without risk-sharing possibilities. Our results are quite sharp: exporters will generally wish to set prices in the currency of the country that has the most stable monetary policy. When monetary stability is similar among countries, there is an equilibrium where firms from all countries set their price in the currency of the buyer (local currency pricing). But except for a special case where money variances are exactly identical across countries, there is no equilibrium where all firms set export prices in their own currencies (producer currency pricing).