Pricing behaviour and the role of trade openness in the transmission of monetary shocks

Laura Povoledo

Working Papers from Department of Accounting, Economics and Finance, Bristol Business School, University of the West of England, Bristol

Abstract: External demand is considered to be one of the channels of transmission of monetary policy to aggregate demand. If external demand matters in the monetary transmission, then the response of output to monetary shocks must be more pronounced in the sectors that are more open to trade and exposed to foreign competition. However, the empirical evidence is not conclusive. Using a New Keynesian open economy model, I show that the role of trade openness in the transmission of monetary shocks can be reversed completely by the degree of exchange-rate pass-through into import prices. If the pass-through is complete, traded output increases more than nontraded output after a positive monetary shock, if the pass-through is zero, traded output increases less. The lack of conclusive evidence on the role of external demand in the transmission of monetary shocks may also be explained by sectoral heterogeneity in price rigidity: if prices are more rigid in the nontraded sector, then it is not possible to find a positive correlation between the response of output to monetary shocks and the degree of openness, regardless of the degree of exchange rate pass-through.

Keywords: Monetary transmission; External demand channel; Exchange rate pass-through (search for similar items in EconPapers)
JEL-codes: E52 F41 (search for similar items in EconPapers)
Date: 2016-01-09
New Economics Papers: this item is included in nep-int, nep-mac, nep-mon and nep-opm
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Journal Article: Pricing behavior and the role of trade openness in the transmission of monetary shocks (2018)
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Persistent link: https://EconPapers.repec.org/RePEc:uwe:wpaper:20161609

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