Introducing dominant‐currency pricing in the ECB's global macroeconomic model

• Author: Saskia Mösle,Georgios Georgiadis
• Published date: 01 August 2020
• DOI: http://doi.org/10.1111/infi.12361
• Date: 01 August 2020

International Finance. 2020;23:234–256.wileyonlinelibrary.com/journal/infi234

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© 2019 John Wiley & Sons Ltd

DOI: 10.1111/infi.12361

ORIGINAL ARTICLE

Introducing dominant‐currency pricing in the

ECB’s global macroeconomic model

Georgios Georgiadis

1

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Saskia Mösle

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1

European Central Bank, Frankfurt,

Germany

2

Kiel Institute for the World Economy,

Kiel, Germany

Correspondence

Georgios Georgiadis, European Central

Bank, Sonnemannstr. 20, 60314

Frankfurt, Germany.

Email: georgios.georgiadis@ecb.int

Abstract

A large share of global trade being priced and invoiced

primarily in U.S. dollar rather than the exporter’sorthe

importer’s currency has important implications for the

transmission of shocks. We introduce this “dominant‐

currency pricing”(DCP) into ECB‐Global, the ECB’s

macroeconomic model for the global economy. To our

knowledge, this is the first attempt to incorporate DCP into

a major global macroeconomic model used at central

banks or international organisations. In ECB‐Global, DCP

affects in particular the role of expenditure‐switching and

the U.S. dollar exchange rate for spillovers: In case of a

shock in a non‐U.S. economy that alters the value of its

currency multilaterally, expenditure‐switching occurs only

through imports; in case of a U.S. shock that alters the

value of the U.S. dollar multilaterally, expenditure‐switch-

ing occurs both in non‐U.S. economies’imports and—as

these are imports of their trading partners—exports.

Overall, under DCP the U.S. dollar exchange rate is a

major driver of global trade, even for transactions that do

not involve the United States. To illustrate the usefulness

of ECB‐Global and DCP for policy analysis, we explore the

implications of the euro rivalling the U.S. dollar as a

second dominant currency in global trade. According to

ECB‐Global, in such a scenario the global spillovers from

U.S. shocks are smaller, whereas those from euro area

shocks are amplified; domestic euro area monetary policy

effectiveness is hardly affected by the euro becoming a

second globally dominant currency in trade.

KEYWORDS

dominant‐currency paradigm, global macroeconomic modelling, spil-

lovers

JEL CLASSIFICATION

F42; E52; C50

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INTRODUCTION

In an increasingly integrated global economy, spillovers and the interdependence of economic

policies have gained immense prominence among commentators. Consequently, there has been

a growing interest in the use of global macroeconomic models, which incorporate rich

transmission channels of cross‐border spillovers for scenario analyses and forecasting. This is

also true for central banks, which increasingly recognise the importance of the global economy

for the evolution of the domestic economy. And especially for major central banks, it has been

increasingly recognised that it is important to account for the effects of domestic monetary

policy on the rest of the world. For example, at the IMF the Flexible System of Global Models

(Andrle et al., 2015) and the Global Integrated Monetary and Fiscal (Laxton & Kumhof, 2007)

model have been used extensively for simulations underpinning the World Economic Outlook;

at the ECB, ECB‐Global (Dieppe, Georgiadis, Ricci, Van Robays, & van Roye, 2017) regularly

provides insights from scenario analyses in different contexts.

In parallel, academic research has recently highlighted the role of dominant‐currency

pricing (DCP) for the domestic and cross‐border transmission of shocks. Traditionally, open‐

economy models assume that exports are priced and invoiced in the currency of the producer,

that is, producer‐currency pricing (PCP), or in the currency of the destination, that is, local‐

currency pricing (LCP). In contrast, the data suggest that a large share of trade is invoiced in a

few dominant currencies (Gopinath, 2015).

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In particular, the data displayed in Figure 1

document that a large share of global trade is invoiced in U.S. dollars. This is the case in

particular for emerging market economies (EMEs), and notably for transactions that do not

involve the United States as a trading partner. Moreover, Chen, Chung, and Novy (2018),

Fitzgerald and Haller (2012), Georgiadis and Schumann (2019) and Gopinath and Rigobon

(2008) provide evidence that export and import prices are sticky in the invoicing currency.

DCP has important implications for the dynamics of trade variables that differ from those under

PCP and LCP. Specifically, Casas, Diez, Gopinath, and Gourinchas (2017) consider a three‐country

New Keynesian dynamic stochastic general equilibrium (NK DSGE) model for the Home economy,

the rest of the world (RoW) and the United States, in which export prices are sticky in U.S. dollars.

In their model, in the case of a multilateral appreciation of the Home currency driven by a

contractionary monetary policy shock, Home terms‐of‐trade are stable as import and export prices

both fall in Home currency terms. This is in contrast to PCP, under which the terms‐of‐trade rise as

Home import prices fall while Home export prices are constant; and this is also in contrast to LCP,

under which the terms‐of‐trade fall as Home import prices in domestic currency remain constant

while Home export prices in domestic currency fall. In turn, the differential responses of the terms‐

of‐trade imply differences in the role of expenditure‐switching in case of a multilateral appreciation

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