Dominant Currencies: How firms choose currency invoicing and why it matters

The currency of invoicing in international trade is central for the international transmission of shocks and macroeconomic policies. Using a new dataset on currency invoicing for Belgian firms, we analyze how firms make their currency choice, for both exports and imports, and the implications of this choice for exchange rate pass-through into prices and quantities. We derive our estimating equations from a theoretical framework that features variable markups, international input sourcing, and staggered price setting with endogenous currency choice, and also allowing for the dominant currency choice. Our structural specification provides a new test of the allocative consequences of nominal rigidities, by estimating the treatment effect of foreign-currency price stickiness on the dynamic response of prices and quantities to exchange rate changes, controlling for the endogeneity of the firm's currency choice. We show that flexible-price determinants of exchange rate pass-through are also the key firm characteristics that determine currency choice. In particular, small non-importing firms tend to price their exports in euros (producer currency) and exhibit close to complete exchange-rate pass-through into destination prices at all horizons. In contrast, large import-intensive firms tend to denominate their exports in foreign currencies, and especially in the US dollar, exhibiting a lower pass-through of the euro-destination exchange rate and a pronounced sensitivity to the dollar-destination exchangerate. Finally, the effects of foreign-currency price stickiness are still significant beyond the one-year horizon, but gradually dissipate in the long run, consistent with sticky price models of currency choice.