The Transmission of Foreign Shocks in a Networked Economy

Pablo Aguilar, Rubén Domínguez-Díaz, José-Elías Gallegos and Javier Quintana
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Pablo Aguilar: BANCO DE ESPAÑA AND ECB
Rubén Domínguez-Díaz: BANCO DE ESPAÑA
José-Elías Gallegos: BANCO DE ESPAÑA
Javier Quintana: BANCO DE ESPAÑA

No 2607, Working Papers from Banco de España

Abstract: We analyze how production networks transmit foreign price shocks and reshape monetary policy trade-offs in an open-economy New Keynesian model with domestic and international input–output linkages. Analytically, we show that closing the output gap does not generally stabilize domestic inflation, as sector-level terms-of-trade movements and trade imbalances become additional drivers of inflation dynamics. Quantitatively, we study an international energy price shock in a model calibrated to major euro area countries and their trade partners. We find that production networks significantly amplify the cumulative headline inflation response and substantially worsen monetary policy trade-offs, as measured by the sacrifice ratio.

Keywords: open economy; production networks; New Keynesian; monetary policy (search for similar items in EconPapers)
JEL-codes: E31 E32 E52 E70 (search for similar items in EconPapers)
Pages: 92 pages
Date: 2026-02
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Persistent link: https://EconPapers.repec.org/RePEc:bde:wpaper:2607

DOI: 10.53479/42526

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