Productivity and Misallocation Dynamics under Dominant Currency Paradigm

Abstract

US monetary policy has a significant impact on the global economy, with recent literature emphasizing the dollar’s role as the dominant currency. This paper examines how US monetary policy affects productivity in non-US economies through allocative efficiency. We develop a two-country model featuring dollar dominance in trade and misallocations from markup heterogeneity. When US monetary policy tightens, dollar appreciation affects non-US economies through two channels. First, it lowers the marginal costs in dollars of non-US exporters, causing large export firms with high markups that underproduce relative to the efficient allocation to incompletely pass through these changes, thereby increasing their markups further. Second, in domestic markets, dollar appreciation raises import prices, easing competitive pressures for local producers. Both effects reallocate resources from large, high-markup firms to small, low-markup firms, worsening allocative efficiency. Using plant-level data from Chile and Colombia, where trade is predominantly invoiced in dollars, we provide evidence of factor reallocation from high-markup to low-markup firms following US monetary tightening.