Openness and Imperfect Pass-Through: Implications for the Monetary Policy
AbstractThis 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 InfoPaper provided by Central Bank of Chile in its series Working Papers Central Bank of Chile with number 216.
Date of creation: Jun 2003
Date of revision:
This paper has been announced in the following NEP Reports:
- NEP-MAC-2003-07-10 (Macroeconomics)
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