Currency choice in international trade: a new monetarist approach and firm-level evidence

Financial market imperfections severely restrict currency use in international trade. We develop a unified search-based framework with financial frictions to address the determinants for currency choice, emphasizing the roles of trade finance and financial market development, as well as macro, micro factors and firm-level bargaining power. In an open economy monetary search model with financial intermediation, the usage of a particular currency will emerge endogenously and strategic complementarities among exporters, importers, and financial intermediation reinforce the status of international currency. With highly disaggregated data from Colombia, we provide firm-level evidence that financial factors significantly affect the patterns of currency usage. We show that exporters prefer the currency with a more developed financial market, especially for small firms in financially vulnerable sectors. In particular, a developing country with medium-level of financial development could enhance its currency usage by more than 10% if they further develop their financial market. Meanwhile, bad monetary policy and low bargaining power of exporters will hurt the popularity of currency, although empirically firm-level bargaining power only has a secondary effect.