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Optimal Monetary Policy with Vertical Production and Trade

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  • Kang Shi
  • Juanyi Xu

Abstract

This paper explores the optimal monetary policy response to domestic and foreign technology shocks in an open economy with vertical structure of production and trade. We find that any stage-specific productivity shock in one country may have a transborder spillover effect on the other country via the vertical trade. So when choosing optimal monetary rules, each monetary authority should respond to both home and foreign productivity shocks. Also, the flexible exchange rate cannot replicate the flexible price equilibrium, even under producer currency pricing, due to price stickiness in multiple stages. We also find that the existence of a transborder spillover effect depends on the currencies of price setting. Finally, vertical trade may affect the value of exchange rate flexibility under PCP and LCP setting. Copyright � 2007 The Authors; Journal compilation � 2007 Blackwell Publishing Ltd.

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Bibliographic Info

Article provided by Wiley Blackwell in its journal Review of International Economics.

Volume (Year): 15 (2007)
Issue (Month): 3 (08)
Pages: 514-537

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Handle: RePEc:bla:reviec:v:15:y:2007:i:3:p:514-537

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Cited by:
  1. Chu, Hsiao-Lei, 2012. "Monetary policy of a small open economy in the world production chain," Economic Modelling, Elsevier, vol. 29(6), pages 2751-2755.
  2. Kang Shi & Juanyi Xu, 2008. "The Optimal Currency Basket with Input Currency and Output Currency," Working Papers 172008, Hong Kong Institute for Monetary Research.
  3. Xu, Juanyi, 2011. "The optimal currency basket under vertical trade," Journal of International Money and Finance, Elsevier, vol. 30(7), pages 1323-1340.
  4. Chan Wang & Heng-fu Zou, 2013. "Optimal monetary policy in open economies: the role of reference currency in vertical production and trade," CEMA Working Papers 586, China Economics and Management Academy, Central University of Finance and Economics.

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