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The Home Market Effect and the International Transmission Mechanism

Giancarlo Corsetti and Philippe Martin

No 132, 2004 Meeting Papers from Society for Economic Dynamics

Abstract: This paper introduces trade costs and endogenous number of varieties in an open economy model with monopolistic competition and short run nominal wage rigidities. We show that these two elements have important implications for the international transmission of monetary and productivity shocks. Imperfect competition coupled with trade costs implies that a monetary expansion increases demand and profits more at Home than in the Foreign country, according to the ''Home market'' effect analyzed in trade models. This in turn leads to entry of new firms or the creation of new varieties. With international portfolio diversification, some of this investment is financed by capital inflows from the Foreign country. We show that this mechanism counter-acts the traditional depreciation effect of a monetary expansion and can lead to a short-term appreciation when trade costs are not zero. We also show that a positive productivity shock leads to an appreciation. We then analyse how the introduction of international borrowing and lending in bonds affects our results

Keywords: Home Market effect; trade costs; exchange rates (search for similar items in EconPapers)
JEL-codes: F32 F41 (search for similar items in EconPapers)
Date: 2004
References: Add references at CitEc
Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:red:sed004:132

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