Gains from monetary policy cooperation under asymmetric currency pricing

Abstract

In most international trade transactions, the U.S. dollar is used. Hence, this study considers optimal monetary policy in a two-country model under asymmetric currency pricing (ACP) in which U.S. (Home) firms use producer currency pricing (PCP) while firms in the rest of the world (Foreign) use local currency pricing (LCP). In the ACP model, there is an additional inefficiency, namely, the internal relative price distortion compared with the LCP model and the distortion arising from deviations from the law of one price compared with the PCP model. Consequently, welfare gains from monetary policy cooperation in the ACP model are substantially greater compared with the LCP and PCP models. Moreover, the noncooperative Foreign policymakers in the ACP model can manipulate not only the internal relative price but also deviations from the law of one price in favor of their own welfare through nominal exchange rate adjustment, whereas the noncooperative Home policymakers can control neither. This result rationalizes the fact that the U.S. designates currency manipulators to protect its welfare. Therefore, gains from cooperation in Home are larger than in Foreign. Furthermore, I find that there are substantial gains from cooperation in the ACP model even under the conditions that remove gains from cooperation in the LCP and PCP models.