【Scholars Point】Trade, finance and international currency co-authored by Tao Liu and others

The paper "Trade, finance andinternational currency" co-authored by our center researcher Tao Liu，Dong Lu of School of Finance，Renmin university of China and Win gThye Woo of School of Economics,Fudan University, was published in Journal of Economic Behavior andOrganization in 24 June 2019.

Abstract

Currency choices in international trade are related to the depthof financial markets, especially in the provision of trade finance. This paperexamines: ( i ) how this financial channel affects international currencychoices and ( ii ) the corresponding macroeconomic implications. Based onunique data with global coverage, we first document the empirical patterns ofinternational currency usage and emphasize the importance of financial marketdevelopment identifying the distinct trade finance channel. We then build atwo-country monetary search model featuring time-to-ship friction and tradefinance arrangements: goods are delivered one period after the contract, andthe lack of commitment between exporters and importers forces the two partiesto rely on bank-intermediated trade finance. The currency choice is endogenizedand related to financial efficiency, terms of trade, and the inflation rate. Wefind that a country issuing a single international currency will: ( i ) enjoyincumbency advantage but have less room when implementing monetary policy; ( ii) face a hump-shaped relationship between its economy size and optimalinflation level; and ( iii ) experience a persistent deficit in internationaltrade. These results are illustrated with numerical examples and have richimplications for the current international monetary system dominated by theU.S. dollar.