Endogenous exchange-rate pass-through and self-validating exchange rate regimes
A long-standing question in open macroeconomics concerns the choice of currency denomination of nominal prices and contracts. A firm serving the export market may choose to set prices in its domestic currency in the currency of the market of destination or in a vehicle currency possibly indexing these prices—fully or partially—to exchange rate movements. To the extent that nominal prices remain sticky the choice among these alternatives has crucial consequences for the design of stabilization policy—by determining the degree of exchange rate pass-through on export/import prices. However the causal relation may also go in the opposite direction as the currency denomination choice may itself depend among other factors on the stabilization strategy pursued by policymakers.