When to Align and When to Contract: Technology Shocks, Optimal Policies, and Exchange Rate Regimes

Hyeongwoo Kim () and Shuwei Zhang

No auwp2025-11, Auburn Economics Working Paper Series from Department of Economics, Auburn University

Abstract: This paper investigates the design of optimal monetary policy responses to technology shocks in a two-country model framework featuring sticky prices and local currency pricing, where technology shocks propagate internationally. We demonstrate that technology shocks originating in the tradable sector, regardless of their country of origin, elicit monetary policy responses that are symmetric and closely aligned across countries, thereby providing a rationale for a fixed exchange rate regime. In contrast, technology shocks in the nontradable sector generate asymmetric policy reactions and weaken the source country's currency, supporting the case for exchange rate flexibility. In addition, the international transmission of technology shocks amplifies real-sector dynamics through news effects, prompting central banks to adopt contractionary policies, starkly contrasting with the findings of previous literature.

Keywords: Sticky Price; Local Currency Pricing; Exchange Rate Regimes; Technology Diffusion; Interest Rate Rules (search for similar items in EconPapers)
JEL-codes: E52 F31 F41 O0 (search for similar items in EconPapers)
Date: 2025-11
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac, nep-mon and nep-opm
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