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Optimal monetary policy in open economies: the role of reference currency in vertical production and trade

Author

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  • Chan Wang

    (China Economics and Management Academy, Central University of Finance and Economics)

  • Heng-fu Zou

    (China Economics and Management Academy, Central University of Finance and Economics
    Institute for Advanced Study, Wuhan University
    Institute for Advanced Study, Shenzhen University)

Abstract

This paper examines optimal monetary policy rules in open economies with vertical production and trade in which we emphasize the role played by reference currency. As evidenced by empirical ï¬ ndings, we assume ï¬ nal goods prices are sticky, but intermediate goods prices are flexible. We ï¬ nd that the asymmetry of exporters' pricing behavior implies that the responses of monetary authorities to productivity shocks from the stage of ï¬ nal goods production are asymmetric but symmetric to productivity shocks from the stage of intermediate goods production. We also ï¬ nd that gains from cooperation are related to the covariance of productivity shocks in two stages. In addition, we give the conditions under which home and foreign are willing to take part in cooperation respectively. As for exchange rate policy, we ï¬ nd that the volatility of nominal exchange rate in RCP case is greater than that in LCP case, but smaller than that in PCP case. The volatility of real exchange rate in RCP case is, however, greater than those in PCP and LCP cases.

Suggested Citation

  • Chan Wang & Heng-fu Zou, 2013. "Optimal monetary policy in open economies: the role of reference currency in vertical production and trade," CEMA Working Papers 586, China Economics and Management Academy, Central University of Finance and Economics.
    • Handle: RePEc:cuf:wpaper:586
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    More about this item

    Keywords

    Vertical production and trade; Reference-currency pricing; Optimal monetary policy; Monetary cooperation; Exchange rates;
    All these keywords.

    JEL classification:

    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
    • F3 - International Economics - - International Finance
    • F4 - International Economics - - Macroeconomic Aspects of International Trade and Finance

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