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Camila Casas, Mr. Federico J Diez, Ms. Gita Gopinath, and Pierre-Olivier Gourinchas
Most trade is invoiced in very few currencies. Despite this, the Mundell-Fleming benchmark and its variants focus on pricing in the producer’s currency or in local currency. We model instead a ‘dominant currency paradigm’ for small open economies characterized by three features: pricing in a dominant currency; pricing complementarities, and imported input use in production. Under this paradigm: (a) the terms-of-trade is stable; (b) dominant currency exchange rate pass-through into export and import prices is high regardless of destination or origin of goods; (c) exchange rate pass-through of non-dominant currencies is small; (d) expenditure switching occurs mostly via imports, driven by the dollar exchange rate while exports respond weakly, if at all; (e) strengthening of the dominant currency relative to non-dominant ones can negatively impact global trade; (f) optimal monetary policy targets deviations from the law of one price arising from dominant currency fluctuations, in addition to the inflation and output gap. Using data from Colombia we document strong support for the dominant currency paradigm.
Mr. Sohrab Rafiq and Mr. David Cowen

rates, as reflected in elevated term premia. Source: Staff calculations. Finally, the modest explanatory power of medium-term inflation expectations for interest rates post-GFC for all G7 countries contrast with predictions made under the fiscal theory of the price level, which links concerns over future inflation to the ratio of public debt. The evidence also implies that the real impact of a change in fiscal policy post-crisis is not likely to have been transmitted through the expected inflation channel. 19 A few caveats are worth noting. First, it is

Mr. Sohrab Rafiq
This paper uses a dataset on private-sector risk aversion as well as expectations of long-run growth and debt to explain trends in implied forward rates on government bonds in the G-7 countries. The results show, consistent with the literature, that a one-percent rise in the long-run projected debt-to-GDP ratio causes an increase in bond yields of a relatively modest 1-to-6 basis points. Shocks to growth expectations and risk aversion have been comparatively more successful in explaining the behavior of long-term rates. The findings imply that growth policies rather than long-run projections of fiscal outcomes may be more important in helping influence long-term borrowing costs.
Camila Casas, Federico J. Díez, Ms. Gita Gopinath, Pierre-Olivier Gourinchas, and Mr. Maurice Obstfeld

price inflation. Strategic complementarities, Г > 0, dampen the impact of movements in real marginal cost or markups on export price inflation. At the same time a higher Г raises the sensitivity of export price inflation to the ratio of export prices to the destination price index (expressed in the same currency) since firms pay more attention to the price of their competitors. A similar interpretation applies to the source/currency specific import price index inflation rate π i H , t j in equ. (25) . Because marginal costs rely on imported inputs, cost-shocks in