Trade Invoicing Currencies and Exchange Rate Pass-through : The Introduction of the Euro as a Natural Experiment

A recent literature emphasizes the prominence of dominant currencies in international trade invoicing, and the role of invoice currencies in the transmission of exchange rate shocks. In this paper, we examine the introduction of the euro as a once-in-a-century natural experiment which induced a substantial shifting in invoice currencies, allowing us to test existing theories. We use unique data on the invoice currencies of the universe of export and import transactions of a small open economy trading with the Eurozone over the period 1997-2010. Before the euro, exports to the Eurozone were dominated by the US dollar, and euro legacy currencies were rarely used. The introduction of the euro led a substantial number of firms to swiftly switch their invoice currencies to euros, which eventually accounted for 40\% of all transactions. We first study the determinants of the adoption of the euro in exports to the Eurozone, finding a key role for strategic complementarities and for the invoice currency of imported inputs. In the core of our analysis, we show how firms switching from dollars to euros faced a radical transformation of their exchange rate pass-through, in line with recent theories. While the literature has studied trade invoice currencies in settings in which these are very persistent firm-level choices, our findings validate the conjecture that large--scale policy changes can lead to changes in these choices, and simultaneous changes in exchange rate pass-through