Optimal monetary policy in a model of vertical production and trade with reference currency

Liutang Gong, Chan Wang and Heng-Fu Zou (hzoucema@gmail.com)

No 611, CEMA Working Papers from China Economics and Management Academy, Central University of Finance and Economics

Abstract: This paper examines optimal monetary policy rules in a model of vertical production and trade with reference currency. As evidenced by empirical findings, we assume that final-goods prices are sticky, but intermediategoods prices are flexible. We find that even if intermediate-goods prices are flexible, monetary authorities need to respond to the shocks at the stage of intermediate-goods production. We also find that, when a shock occurs at the stage of final-goods production, monetary responses are independent of the expenditure share of finalgoods producers on intermediate goods. For the first time in the literature, our model gives a condition under which both countries are willing to participate in monetary cooperation. Thus the gains from cooperation are real. In addition, we compare the volatility of the nominal exchange rate in Nash case with that in cooperative case, and compare the volatility of the nominal exchange rate in our model with that in a model without vertical production and trade as well. We also extend the model to consider a case of dual price stickiness. We find that the change in solution methods completely alters the conclusions of the model.

Keywords: exchange rates; monetary cooperation; optimal monetary policy; reference-currency pricing; vertical production and trade (search for similar items in EconPapers)
JEL-codes: E5 F3 F4 (search for similar items in EconPapers)
Pages: 21 pages
Date: 2020
New Economics Papers: this item is included in nep-cba, nep-mac, nep-mon, nep-opm and nep-ore
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