Financial Hedging and Optimal Currency of Invoicing

I develop a theory on the optimal currency choice for invoicing international goods trade in the presence of imperfect financial hedging of currency risk. I demonstrate that the classic irrelevance result—that the cost of external financial hedging does not impact the choice of currency for invoicing—rests on the assumption that sellers set prices ex-ante and commit to fulfill any order size ex-post. I refer to this set-up as sticky prices and flexible quantities. I show that when quantities are also sticky, in the sense that the order quantity is pre-specified, then financial hedging affects the optimal currency of invoicing choice. My theory of jointly sticky prices and quantities incorporates financial frictions into existing theories of real hedging. I show that this financial hedging channel is quantitatively relevant and that it generates a feedback between macroprudential policies that affect the cost of hedging, such as capital controls on domestic versus foreign borrowing, and the optimal currency of invoicing. As a result, macroprudential policies can affect the expenditure switching properties of the exchange rate by inducing a different choice of optimal currency of invoicing.