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Openness and Imperfect Pass-Through: Implications for the Monetary Policy

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  • Claudio Soto
  • Jorge Selaive

Abstract

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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Bibliographic Info

Paper provided by Central Bank of Chile in its series Working Papers Central Bank of Chile with number 216.

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Date of creation: Jun 2003
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Handle: RePEc:chb:bcchwp:216

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  1. Ariel T. Burstein & Joao C. Neves & Sergio Rebelo, 2000. "Distribution Costs and Real Exchange Rate Dynamics During Exchange-Rate-Based-Stabilizations," NBER Working Papers 7862, National Bureau of Economic Research, Inc.
  2. Charles Engel, 1999. "Local-Currency Pricing and the Choice of Exchange-Rate Regime," Discussion Papers in Economics at the University of Washington 0036, Department of Economics at the University of Washington.
  3. Pinelopi Koujianou Goldberg & Michael M. Knetter, 1997. "Goods Prices and Exchange Rates: What Have We Learned?," Journal of Economic Literature, American Economic Association, vol. 35(3), pages 1243-1272, September.
  4. Michael B. Devereux & Charles Engel, 2000. "Monetary Policy in the Open Economy Revisited: Price Setting and Exchange Rate Flexibility," NBER Working Papers 7665, National Bureau of Economic Research, Inc.
  5. Maurice Obstfeld & Kenneth Rogoff, 2000. "New Directions for Stochastic Open Economy Models," International Finance 0004002, EconWPA.
  6. Obstfeld, Maurice & Rogoff, Kenneth, 1995. "Exchange Rate Dynamics Redux," CEPR Discussion Papers 1131, C.E.P.R. Discussion Papers.
  7. Betts, Caroline & Devereux, Michael B., 2000. "Exchange rate dynamics in a model of pricing-to-market," Journal of International Economics, Elsevier, vol. 50(1), pages 215-244, February.
  8. Roberts, Mark J & Tybout, James R, 1997. "The Decision to Export in Colombia: An Empirical Model of Entry with Sunk Costs," American Economic Review, American Economic Association, vol. 87(4), pages 545-64, September.
  9. Betts, Caroline & Devereux, Michael B., 1996. "The exchange rate in a model of pricing-to-market," European Economic Review, Elsevier, vol. 40(3-5), pages 1007-1021, April.
  10. Friberg, Richard & Nydahl, Stefan, 1999. "Openness and the Exchange Rate Exposure of National Stock Markets," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 4(1), pages 55-62, January.
  11. Lane, P, 1999. "The New Open Economy Macroeconomics: A Survey," Trinity Economics Papers 993, Trinity College Dublin, Department of Economics.
  12. Charles Engel, 2002. "Expenditure Switching and Exchange Rate Policy," NBER Working Papers 9016, National Bureau of Economic Research, Inc.
  13. Sebastian Edwards, 1997. "Openness, Productivity and Growth: What Do We Really Know?," NBER Working Papers 5978, National Bureau of Economic Research, Inc.
  14. Devereux, Michael B & Engel, Charles M, 2000. "Monetary Policy In The Open Economy Revisited: Price Setting Rules And Exchange Rate Flexibility," CEPR Discussion Papers 2454, C.E.P.R. Discussion Papers.
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Cited by:
  1. Pierpaolo Benigno & Ester Faia, 2010. "Globalization, Pass-Through and Inflation Dynamics," Kiel Working Papers 1604, Kiel Institute for the World Economy.
  2. Waldyr Areosa & Marta Areosa, 2012. "The Signaling Effect of Exchange Rates: pass-through under dispersed information," Working Papers Series 282, Central Bank of Brazil, Research Department.
  3. Fabrizio Coricelli & Balázs Égert & Ronald MacDonald, 2006. "Monetary Transmission Mechanism in Central & Eastern Europe: Gliding on a Wind of Change," William Davidson Institute Working Papers Series wp850, William Davidson Institute at the University of Michigan.
  4. Balázs Égert & Ronald MacDonald, 2006. "Monetary Transmission Mechanism in Transition Economies: Surveying the Surveyable," MNB Working Papers 2006/5, Magyar Nemzeti Bank (the central bank of Hungary).
  5. Fabrizio Coricelli & Balázs Égert & Ronald MacDonald, 2006. "Monetary Transmission in Central and Eastern Europe: Gliding on a Wind of Change," Focus on European Economic Integration, Oesterreichische Nationalbank (Austrian Central Bank), issue 1.

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