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Production interdependence and welfare

  • Huang, Kevin X. D.
  • Liu, Zheng

The international welfare effects of a country's monetary policy shocks have been controversial in the new open economy macro (i.e., NOEM) literature. While a unilateral monetary expansion increases the production efficiency in each country, it affects the terms of trade in favor of one country against another depending on the currencies of price setting. In this paper, we incorporate multiple stages of production and trade into a standard NEOM model to capture world production interdependence, and show that increased world production interdependence tends to magnify the e±ciency-improvement effect while dampening the terms-of-trade effect. As a consequence, a unilateral monetary expansion can be mutually beneficial regardless of in which currency prices are set. In this sense, international monetary policy transmission may not be a source of potential conflict in a world with production interdependence. JEL Classification: E32, F31, F41

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Paper provided by European Central Bank in its series Working Paper Series with number 0355.

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Date of creation: May 2004
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Handle: RePEc:ecb:ecbwps:20040355
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  1. Michael B. Devereux & Charles Engel, 2001. "The Optimal Choice of Exchange Rate Regime: Price-Setting Rules and Internationalized Production," NBER Chapters, in: Topics in Empirical International Economics: A Festschrift in Honor of Robert E. Lipsey, pages 163-194 National Bureau of Economic Research, Inc.
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