1.1 OVERVIEW OF THE STUDY
In response to recent developments in international macroeconomics theory, there has been a strong interest among academics and central bankers regarding a firm’s choice of a currency to price its exports. Since Obstfeld and Rogoff (1995) published their work on new open-economy macroeconomics, a dynamic general equilibrium open-economy model with micro foundations, many researchers have incorporated the firm’s invoicing decision into this model. The New Open Economy Macroeconomics (henceforth NOEM) is a leading development in international economics starting in the early 1990s. Its objective is to provide a new theoretical framework for open economy analysis and policy design, overcoming the limitations of the Mundell-Fleming model, while preserving the empirical wisdom and the close connection to policy debates of the traditional literature. This line of research shows that the transmission of monetary policy, optimal monetary policy rules and the optimal exchange rate regime all depend on the firm’s choice of an invoice currency for exporting its goods, that is, whether it chooses producer currency pricing (PCP), consumer currency pricing (CCP), or vehicle currency pricing (VCP). This describes a firm’s currency invoicing behavior regarding its export price setting. A firm quotes the price of its exports in producer currency (PCP), consumer currency (CCP), or vehicle currency (VCP).
1.2 BACKGROUND OF THE STUDY
Prior to July 2005, China maintained a de facto peg to the U.S. dollar and the movement of the Chinese renminbi exchange rate against the dollar was stable. Combined with the fact that the U.S. dollar is the world’s vehicle currency for most international transactions, the majority of China’s exports are deno ...