Endogenous Exchange-Rate Pass-through and Self-Validating Exchange Rate Regimes
Abstract
A long-standing question in open macroeconomics concerns the choice of currency denomination of nominal prices and contracts. This paper analyzes the interaction between firms’ export pricing and monetary policy, and discusses its potential macroeconomic implications for business cycle synchronization and the choice of an exchange rate regime. In the framework of a highly stylized monetary model, we provide an analytical characterization of the optimal export pricing by imperfectly monopolistic firms subject to nominal rigidities. We show that, when choosing the currency denomination of exports, firms optimize over the covariance between the log of the exchange rate and the inverse of the markup. Intuitively, the currency denomination of exports affects the exposure of firms’ marginal revenue to the shocks moving the exchange rate and demand in the destination markets.
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