Exchange Rates and Monetary Policy When Tradable and Nontradable Goods are Complements

William Craighead

No 2021-01, Working Papers from Department of Economics and Geosciences, US Air Force Academy

Abstract: This paper examines the implications of complementarity between tradable and nontradable goods for exchange rates and monetary policy in a two-country general equilibrium model. In doing so, it revisits well-known findings in the New Open Economy Macroeconomics literature that exchange rates are proportional to national money supplies and that optimal monetary policies respond only to domestic shocks. These results depend on a number of simplifying assumptions, including a unitary elasticity of substitution between tradable and nontradable goods. When this assumption is replaced by a more-realistic one of complementarity, exchange rates depend on relative productivity in addition to money supplies when prices are flexible. When prices are sticky, complementarity amplifies the effect of relative money supplies on the exchange rate and creates additional spillover effects from changes of the foreign money supply on domestic consumption. With complementarity, optimal monetary policies respond to external as well as internal shocks.

Keywords: Complementarity; New Open Economy Macroeconomics; Exchange Rates; Monetary Policy; Nontradable Goods (search for similar items in EconPapers)
JEL-codes: E52 F42 (search for similar items in EconPapers)
Pages: 30 pages
Date: 2021-08
New Economics Papers: this item is included in nep-cba, nep-mac, nep-mon and nep-opm
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https://www.usafa.edu/app/uploads/usafawp2021-01.pdf First version, 2021 (application/pdf)

Related works:
Journal Article: Exchange rates and monetary policy when tradable and nontradable goods are complements (2024)
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Persistent link: https://EconPapers.repec.org/RePEc:ats:wpaper:wp2021-1

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