WP 3/2002: Optimal Contract Currencies and Exchange Rate Policy

Working paper no 3, 2002

Authors Storgaard, Peter Ejler
Subject Monetary- and foreign-exchange policy; Foreign-exchange policy and -cooperation
Type Working paper
Year 2002
Published 23 May 2002
The paper develops a simple stochastic new open macroeconomic model in which price-setting firms' choice between producer currency pricing and local currency pricing is endogenous. We show that, in equilibrium, firms will denominate their export price contracts in the currency of the country with the lowest level of monetary variability. A welfare maximising government's choice of exchange rate regime is also analysed, and we find that a fixed exchange rate is preferable if the domestic monetary variability is higher than the foreign one.