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The Currency Denomination of Trade and Price Discrimination: The Euro after European Union Expansion Mark David Witte College of Charleston Slide 2 What is Currency Denomination? Exporting firms must choose a currency in which to denominate their price. Importing countrys currency = Local Currency Pricing (LCP) Exporting countrys currency = Producer Currency Pricing (PCP) A third countrys currency = Vehicle Currency Pricing (VCP) Slide 3 Why currency denomination matters Persistent, heightened price volatility when imports are denominated in another countrys currency (inflation volatility). Gopinath, Itskhoki and Rigobon (2007) Imports denominated in another currency = heightened vulnerability to macro shocks of other countries Goldberg and Tille (2007) Slide 4 Euro Invoicing of Imports 02 or 03 -Source: Goldberg (2005), ECB (2005) Slide 5 Model Representative Firm must choose currency of denomination, frequency of price adjustment and degree of price discrimination. Novel multiple market structure. Original EU country EU Accession country Non-EU country (Exporters country) Slide 6 Different Representative Firms Randomly assigned parameters Exchange rate transaction costs, wage inflation, menu costs, country market size, elasticity of demand, reference price volatility, firms risk aversion, marginal cost, law of one price failure Bachetta and van Wincoop (2005), Friberg (1998), Black (1991), Taylor (2000), Goldberg and Tille (2006). Slide 7 Results -5,000 representative firms -Pre-EU expansion and Post-EU expansion -Representative firms market, cost and demand are unchanged, the only change is the EU-expansion countrys currency. Slide 8 When LCP? Obvious: Failure in Law of One Price Difference in demand elasticity across countries = Different preferences across countries Different preferences in different countries Price discrimination Price discrimination (setting different prices in each country) Invoice in buyers currency Slide 9 Firms price discriminating? Greater differences in demand elasticity = different preferences more price discrimination Slide 10 Invoicing with price discrimination Price discrimination (setting different prices in each country) Invoice in buyers currency Slide 11 Summary Different preferences and Law of One Price Failure leads to price discrimination More price discrimination leads to greater invoicing in buyers currency Theoretical results fit observed data