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The Home Market Effect and the International Transmission Mechanism

Author

Listed:
  • Giancarlo Corsetti
  • Philippe Martin

Abstract

This paper introduces trade costs and endogenous number of varieties in an open economy model with monopolistic competition and short run nominal wage rigidities. We show that these two elements have important implications for the international transmission of monetary and productivity shocks. Imperfect competition coupled with trade costs implies that a monetary expansion increases demand and profits more at Home than in the Foreign country, according to the ''Home market'' effect analyzed in trade models. This in turn leads to entry of new firms or the creation of new varieties. With international portfolio diversification, some of this investment is financed by capital inflows from the Foreign country. We show that this mechanism counter-acts the traditional depreciation effect of a monetary expansion and can lead to a short-term appreciation when trade costs are not zero. We also show that a positive productivity shock leads to an appreciation. We then analyse how the introduction of international borrowing and lending in bonds affects our results

Suggested Citation

  • Giancarlo Corsetti & Philippe Martin, 2004. "The Home Market Effect and the International Transmission Mechanism," 2004 Meeting Papers 132, Society for Economic Dynamics.
    • Handle: RePEc:red:sed004:132
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    Cited by:

    1. Dohwa, Kohjiro, 2018. "The role of local currency pricing in international transmission effects of monetary and productivity shocks in an economy with vertical production linkage and firm entry," MPRA Paper 86351, University Library of Munich, Germany.

    More about this item

    Keywords

    Home Market effect; trade costs; exchange rates;
    All these keywords.

    JEL classification:

    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements

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