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Exchange rates and monetary policy when tradable and nontradable goods are complements

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  • Craighead, William D.

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 relative 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 changes in relative money supplies on the exchange rate and creates additional spillover effects from changes in the foreign money supply to domestic consumption. With complementarity, optimal monetary policies respond to external as well as internal shocks.

Suggested Citation

  • Craighead, William D., 2024. "Exchange rates and monetary policy when tradable and nontradable goods are complements," International Review of Economics & Finance, Elsevier, vol. 89(PA), pages 297-309.
    • Handle: RePEc:eee:reveco:v:89:y:2024:i:pa:p:297-309
    DOI: 10.1016/j.iref.2023.07.058
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    More about this item

    Keywords

    New open economy macroeconomics; Nontradable goods; Complementarity; Optimal monetary policy;
    All these keywords.

    JEL classification:

    • F42 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - International Policy Coordination and Transmission
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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