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Production interdependence and welfare

  • Kevin X.D. Huang
  • Zheng Liu

The international welfare effects of a country’s monetary policy shocks have been controversial in the literature. While a unilateral monetary expansion increases the production efficiency in each country, it affects terms of trade in favor of one country against another depending on the currencies of price setting. We show that the increased world production interdependence magnifies the efficiency-improvement effect while dampening the terms-of-trade effect. As a consequence, a unilateral monetary expansion can be mutually beneficial and thus Pareto improving regardless of in which currency unit prices are set. In this sense, international monetary policy transmission may not be a source of potential conflict in a world with production interdependence.

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Paper provided by Federal Reserve Bank of Kansas City in its series Research Working Paper with number RWP 04-04.

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Date of creation: 2004
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Handle: RePEc:fip:fedkrw:rwp04-04
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