Most trade is invoiced in very few currencies. Despite this, the Mundell-Fleming benchmark and its variants assume prices are set in the producer's currency or in local currency. We model instead a 'dominant currency paradigm' characterized by three features: pricing in a dominant currency, pricing complementarities, and imported input use in production. We test this paradigm using both a newly constructed data set of bilateral price and volume indices for more than 2,500 country pairs that covers 91% of world trade, and using firm level evidence from Colombia. In strong support of the paradigm we find that:

(1) Non-commodities terms of trade are essentially uncorrelated with exchange rates.

(2) The dollar exchange rate quantitatively dominates the bilateral exchange rate in price pass-through and trade elasticity regressions, and this effect is increasing in the share of imports invoiced in dollars.

(3) U.S. import volumes are significantly less sensitive to the bilateral exchange rate, as compared to other countries' imports.

(4) A 1% U.S. dollar appreciation against all other currencies in the world predicts a 0.6% decline within a year in the volume of total trade between countries in the rest of the world, controlling for the global business cycle.

The Development Economics Vice Presidency (DEC) launched its lecture series to bring distinguished academics to the Bank to present and discuss new knowledge on development. The purpose of the Lecture Series is to introduce ideas on cutting edge research, challenge and contribute to the Bank's intellectual climate, and reexamine current development theories and practices.

The DEC Lecture Series is chaired by Shanta Devarajan, Acting WBG Chief Economist and Senior Director, Development Economics, and includes a presentation and floor discussion.