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Monetary Policy in an Era of Global Supply Chains

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  • Shang-Jin Wei
  • Yinxi Xie

Abstract

We study the implications of global supply chains for the design of monetary policy, using a small-open economy New Keynesian model with multiple stages of production. Within the family of simple monetary policy rules with commitment, a rule that targets separate producer price inflation at different production stages, in addition to output gap and real exchange rate, is found to deliver a higher welfare level than alternative policy rules. As an economy becomes more open, measured by the export share, the optimal weight on the upstream inflation rises relative to that on the final stage inflation. If we have to choose among aggregate price indicators, targeting PPI inflation yields a smaller welfare loss than targeting CPI inflation alone. As the production chain becomes longer, the optimal weight on PPI inflation in the policy rule that targets both PPI and CPI inflation will also rise. A trade cost shock such as a rise in the import tariff can alter the optimal weights on different inflation variables.

Suggested Citation

  • Shang-Jin Wei & Yinxi Xie, 2020. "Monetary Policy in an Era of Global Supply Chains," NBER Working Papers 26602, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:26602
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    More about this item

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • F4 - International Economics - - Macroeconomic Aspects of International Trade and Finance

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