Openness and Imperfect Pass-Through: Implications for the Monetary Policy
Claudio Soto () and
Jorge Selaive ()
Working Papers Central Bank of Chile from Central Bank of Chile
This paper analyzes the positive and normative implications of the degree of openness of a small economy for the transmission mechanism of monetary shocks. First, we show empirical evidence on the direct relationship between openness and the degree of exchange rate pass-through. Then, we develop a general equilibrium model where countries do not fully specialize according to their comparative advantages. With this framework we show that incomplete specialization makes the pass-through from exchange rate to import prices imperfect. The less open is the country --the less specialized- the lower is the pass-through from exchange rate to import prices. Despite the fact that the pass-through is incomplete and the expenditure switching effect is diminished, the flexible price allocation can still be reached with an inward-oriented monetary policy.
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Persistent link: https://EconPapers.repec.org/RePEc:chb:bcchwp:216
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