Does Trade Integration Alter Monetary Policy Transmission?

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Does Trade Integration Alter Monetary Policy Transmission?

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Tobias J. Cwik () (Goethe Uniyversity Frankfurt)
Gernot J. Müller () (Goethe University Frankfurt)
Maik Wolters () (Goethe University Frankfurt)

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Gernot Johannes Müller

Abstract

This paper explores the role of trade integration—or openness—for monetary policy transmission in a medium-scale New Keynesian model. Allowing for strategic complementarities in price-setting, we highlight a new dimension of the exchange rate channel by which monetary policy directly impacts domestic inflation. Although the strength of this effect increases with economic openness, it also requires that import prices respond to exchange rate changes. In this case domestic producers find it optimal to adjust their prices to exchange rate changes which alter the domestic currency price of their foreign competitors. We pin down key parameters of the model by matching impulse responses obtained from a vector autoregression on U.S. time series relative to an aggregate of industrialized countries. While we find evidence for strong complementarities, exchange rate pass-through is limited. Openness has therefore little bearing on monetary transmission in the estimated model.

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Paper provided by Center for Financial Studies in its series CFS Working Paper Series with number 2008/29.

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Length: 35 pages
Date of creation: 18 Aug 2008
Date of revision:
Handle: RePEc:cfs:cfswop:wp200829

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Find related papers by JEL classification:
F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
F42 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - International Policy Coordination and Transmission
E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles

This paper has been announced in the following NEP Reports:

NEP-ALL-2009-06-03 (All new papers)
NEP-CBA-2009-06-03 (Central Banking)
NEP-IFN-2009-06-03 (International Finance)
NEP-MAC-2009-06-03 (Macroeconomics)
NEP-MON-2009-06-03 (Monetary Economics)
NEP-OPM-2009-06-03 (Open MacroEconomics)

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