Trade, Unemployment, and Monetary Policy

Fabio Ghironi and Matteo Cacciatore

No 14952, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: We study how trade linkages affect the conduct of monetary policy in a two-country model with heterogeneous firms, endogenous producer entry, and labor market frictions. We show that the ability of the model to replicate key empirical regularities following trade integration---synchronization of business cycles across trading partners and reallocation of market shares toward more productive firms---is central to understanding how trade costs affect monetary policy trade-offs. First, productivity gains through firm selection reduce the need of positive inflation to correct long-run distortions. As a result, lower trade costs reduce the optimal average inflation rate. Second, as stronger trade linkages increase business cycle synchronization, country-specific shocks have more global consequences. Thus, the optimal stabilization policy remains inward looking. By contrast, sub-optimal, inward-looking stabilization---for instance too narrow a focus on price stability---results in larger welfare costs when trade linkages are strong due to inefficient fluctuations in cross-country aggregate demand.

Keywords: Trade integration; Optimal monetary policy (search for similar items in EconPapers)
JEL-codes: E24 E32 E52 F16 F41 J64 (search for similar items in EconPapers)
Date: 2020-06
New Economics Papers: this item is included in nep-dge, nep-int, nep-mac, nep-mon and nep-opm
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

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Related works:
Journal Article: Trade, unemployment, and monetary policy (2021)
Working Paper: Trade, Unemployment, and Monetary Policy (2020)
Working Paper: Trade, Unemployment, and Monetary Policy (2013)
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