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International Transmission Effects of Monetary Policy Shocks: Can Asymmetric Price Setting Explain the Stylized Facts?

How does an unexpected domestic monetary expansion a.ect the foreign economy? Does it induce an increase or a decline in foreign production? In the traditional two-country Mundell-Fleming model, monetary policy has «beggar-thy-neighbor» effects. Yet, empirical evidence from VARs indicates that U.S. monetary policy has positive international transmission effects on both foreign (non-U.S. G-7) output and aggregate demand. In this paper, I will show that a two-country dynamic general equilibrium model with sticky prices can account for these «stylized facts» if we allow for international asymmetries in the price-setting behavior of firms. If U.S. firms set export prices in their own currency only (producer-currency pricing), whereas producers in the rest of the world price their exports to the U.S. in the local currency of the export market (local-currency pricing), a U.S. monetary expansion is found to increase output and aggregate demand abroad.

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Paper provided by KOF Swiss Economic Institute, ETH Zurich in its series KOF Working papers with number 05-102.

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Length: 51 pages
Date of creation: Mar 2005
Date of revision:
Handle: RePEc:kof:wpskof:05-102
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