Optimal monetary policy with international trade in intermediate inputs

Liutang Gong, Chan Wang and Heng-Fu Zou ()

Journal of International Money and Finance, 2016, vol. 65, issue C, 140-165

Abstract: This paper examines optimal monetary policy in a two-country New Keynesian model with international trade in intermediate inputs. We derive the loss function of a cooperative monetary policymaker and find that the optimal monetary policy must target intermediate-goods price inflation rates, final-goods price inflation rates, final-goods output gaps, and relative-price gaps. We use the welfare loss under the optimal monetary policy as a benchmark to evaluate the welfare implications of three Taylor-type monetary policy rules. A main finding is that the degree of price stickiness at the stage of intermediate-goods production is a key factor to determine which policy rule should be followed. Specifically, when the degree of price stickiness at the stage of intermediate-goods production is high, the policymaker should follow intermediate-goods PPI-based Taylor rule, whereas CPI-based Taylor rule should be followed when the degree of price stickiness at the stage of intermediate-goods production is intermediate or low.

Keywords: Vertical production and trade; Optimal monetary policy; Inflation targeting; Welfare (search for similar items in EconPapers)
JEL-codes: E5 F3 F4 (search for similar items in EconPapers)
Date: 2016
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (16)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jimfin:v:65:y:2016:i:c:p:140-165

DOI: 10.1016/j.jimonfin.2016.03.007

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