The role of local currency pricing in international transmission effects of monetary and productivity shocks in an economy with vertical production linkage and firm entry

In this paper, we construct a two-country model with the three factors of asymmetry in price-setting behavior between home and foreign intermediate goods firms, vertical production and trade, and endogenous entry of home and foreign final goods firms. We mainly examine the effect of asymmetric price-setting behavior on the welfare effects of monetary and productivity shocks, taking into account firm entry and exit. We show that when the ratio of home and/or foreign intermediate goods firms that set their export prices in the local currency rises, a home monetary shock has a beggar-thy-neighbor effect. In scenarios other than one where the ratios of both countries' intermediate goods firms that set their export prices in the local currency are unity, we show that the two types of home productivity shocks cause foreign welfare to deteriorate. When the ratios of both countries' intermediate goods firms that set their export prices in the local currency are unity, we show that the two types of home productivity shocks have a different effect on foreign welfare.