Currency Choice in Contracts

Andres Drenik, Rishabh Kirpalani, Diego J. Perez

    Research output: Contribution to journalArticlepeer-review


    We study the interaction between the currency choice of private domestic contracts and optimal monetary policy. The optimal currency choice depends on the price risk of each currency, as well as on the covariance of its price and the relative consumption needs of the agents signing the contract. When a larger share of contracts is denominated in local currency, the government can use inflation more effectively to either redistribute resources or reduce default costs, which makes local currency more attractive for private contracts. When governments lack commitment, competitive equilibria can be constrained inefficient, thus providing a reason to regulate the currency choice of private contracts. We show that both the equilibrium use of local currency and the implications for regulation depend on the level of domestic policy risk. Our model can explain the wide use of the US dollar in international trade contracts and the observed hysteresis in dollarization.

    Original languageEnglish (US)
    Pages (from-to)2529-2558
    Number of pages30
    JournalReview of Economic Studies
    Issue number5
    StatePublished - Oct 1 2022


    • Contracts
    • Currency choice
    • Monetary policy

    ASJC Scopus subject areas

    • Economics and Econometrics


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