Does Trade Integration Alter Monetary Policy Transmission?

Müller, Gernot, Tobias Cwik and Maik Wolters
Authors registered in the RePEc Author Service: Gernot J. Müller

No 8026, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: This paper explores the role of trade integration - or openness - for monetary policy transmission in a medium-scale new Keynesian model. Allowing for strategic complementarities in price-setting, we highlight a new dimension of the exchange rate channel by which monetary policy directly impacts domestic inflation: a monetary contraction which appreciates the exchange rate lowers the local currency price of imported goods; this, in turn, induces domestic producers to lower their prices too. We pin down key parameters of the model by matching impulse responses obtained from a vector autoregression on time series for the US relative to the euro area. Our estimation procedure yields plausible parameter values and suggests a strong role for strategic complementarities. Counterfactual simulations show that openness alters monetary transmission significantly. While the contractionary effect of a monetary policy shock on inflation and output tends to increase in openness, we find that monetary policy's control over inflation increases, as the output decline which is necessary to bring about a given reduction of inflation is smaller in more open economies.

Keywords: Exchange rate channel; Monetary policy transmission; Open economy; Strategic complementarity; Trade integration (search for similar items in EconPapers)
JEL-codes: E52 F41 F42 (search for similar items in EconPapers)
Date: 2010-09
New Economics Papers: this item is included in nep-cba, nep-mac, nep-mon and nep-opm
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (4)

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Related works:
Journal Article: Does trade integration alter monetary policy transmission? (2011)
Working Paper: Does trade integration alter monetary policy transmission? (2008)
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