The Choice Theory of Vehicle Currency in International Trade: An Application for Iran

Authors

1 Department of Economics, Semnan University, Semnan, Iran

2 Department of Economics, University of Isfahan , Isfahan, Iran

Abstract

In international trade relations, the US dollar is prominently used for invoicing, and not only for a trade involving the United States but also for other countries, it is so-called vehicle currency. This paper analytically explores the optimal policy and its implications for welfare in a two-country general equilibrium model with non-tradable goods, considering various assumptions about export invoicing currency. Fixing invoicing currency for one country’s exports, compared to the other country’s welfare under the two possible invoicing currencies, is this paper’s main analysis. This paper derives an analytical condition under which both vehicle currency country and the non-vehicle currency country prefer vehicle currency pricing over producer currency pricing. Finally, this paper uses the choice theory of vehicle currency to explore its role in Iran’s international trade. The Empirical findings show that for each value of tradable goods weight, if the bias parameter toward domestically-produced goods for foreign households equals 0.33, then Rial (home country currency) is used as a vehicle currency.
 

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