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When to Align and When to Contract: Technology Shocks, Optimal Policies, and Exchange Rate Regimes

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  • Hyeongwoo Kim
  • Shuwei Zhang

Abstract

This paper characterizes optimal monetary policy responses to technology shocks in a two-country model with sticky prices, local currency pricing, and international technology diffusion. We show that technology shocks originating in the tradable sector, regardless of their country of origin, elicit symmetric and closely coordinated monetary policy responses across countries, providing a rationale for a fixed exchange rate regime. By contrast, technology shocks originating in the nontradable sector generate asymmetric policy responses and depreciate the source country's currency, supporting the case for exchange rate flexibility. We further show that the international transmission of technology shocks amplifies real sector dynamics through news effects, prompting central banks to adopt contractionary policies, a result that stands in sharp contrast to the prior literature.

Suggested Citation

  • Hyeongwoo Kim & Shuwei Zhang, 2026. "When to Align and When to Contract: Technology Shocks, Optimal Policies, and Exchange Rate Regimes," Auburn Economics Working Paper Series auwp2026-05, Department of Economics, Auburn University.
    • Handle: RePEc:abn:wpaper:auwp2026-05
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    References listed on IDEAS

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    1. Backus, David K. & Smith, Gregor W., 1993. "Consumption and real exchange rates in dynamic economies with non-traded goods," Journal of International Economics, Elsevier, vol. 35(3-4), pages 297-316, November.
    2. Duarte, Margarida & Obstfeld, Maurice, 2008. "Monetary policy in the open economy revisited: The case for exchange-rate flexibility restored," Journal of International Money and Finance, Elsevier, vol. 27(6), pages 949-957, October.
    3. Svensson, Lars E O & van Wijnbergen, Sweder, 1989. "Excess Capacity, Monopolistic Competition, and International Transmission of Monetary Disturbances," Economic Journal, Royal Economic Society, vol. 99(397), pages 785-805, September.
    4. 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.
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    Keywords

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    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • O0 - Economic Development, Innovation, Technological Change, and Growth - - General
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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