Internationalised Production in a Small Open Economy
We show that internationalised production, modelled as trade in intermediate goods, brings the dynamics of a small open economy closer to that observed in the data. We build a stylized new-Keynesian small open economy model and we show that when production is internationalised, movements of international relative prices affect the economy through an additional channel, denoted as the “cost channel”. Both qualitatively and quantitatively, this channel (i) increases the share of output variance explained by foreign shocks, consistent with empirical evidence, (ii) implies that the exchange rate pass-through is closer to estimated values, and (iii) increases the international correlation of output relative to that of consumption.
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- Hummels, David & Ishii, Jun & Yi, Kei-Mu, 2001.
"The nature and growth of vertical specialization in world trade,"
Journal of International Economics,
Elsevier, vol. 54(1), pages 75-96, June.
- David L. Hummels & Jun Ishii & Kei-Mu Yi, 1999. "The nature and growth of vertical specialization in world trade," Staff Reports 72, Federal Reserve Bank of New York.