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When to Align and When to Contract: Technology Shocks, Optimal Policies, and Exchange Rate Regimes

Author

Listed:
  • Hyeongwoo Kim

    (Department of Economics, Auburn University)

  • Shuwei Zhang

    (Department of Economics, Towson University)

Abstract

This paper investigates the design of optimal monetary policy responses to technology shocks in a two-country model framework featuring sticky prices and local currency pricing, where technology shocks propagate internationally. We demonstrate that technology shocks originating in the tradable sector, regardless of their country of origin, elicit monetary policy responses that are symmetric and closely aligned across countries, thereby providing a rationale for a fixed exchange rate regime. In contrast, technology shocks in the nontradable sector generate asymmetric policy reactions and weaken the source country's currency, supporting the case for exchange rate flexibility. In addition, the international transmission of technology shocks amplifies real-sector dynamics through news effects, prompting central banks to adopt contractionary policies, starkly contrasting with the findings of previous literature.

Suggested Citation

  • Hyeongwoo Kim & Shuwei Zhang, 2026. "When to Align and When to Contract: Technology Shocks, Optimal Policies, and Exchange Rate Regimes," Working Papers 2026-03, Towson University, Department of Economics, revised Mar 2026.
    • Handle: RePEc:tow:wpaper:2026-03
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    References listed on IDEAS

    as
    1. Svensson, Lars E O & van Wijnbergen, Sweder, 1989. "Excess Capacity, Monopolistic Competition, and International Transmission of Monetary Disturbances," Economic Journal, Royal Economic Society, vol. 99(397), pages 785-805, September.
    2. Backus, David K. & Smith, Gregor W., 1993. "Consumption and real exchange rates in dynamic economies with non-traded goods," Journal of International Economics, Elsevier, vol. 35(3-4), pages 297-316, November.
    3. Duarte, Margarida & Obstfeld, Maurice, 2008. "Monetary policy in the open economy revisited: The case for exchange-rate flexibility restored," Journal of International Money and Finance, Elsevier, vol. 27(6), pages 949-957, October.
    4. Pinelopi Koujianou Goldberg & Michael M. Knetter, 1997. "Goods Prices and Exchange Rates: What Have We Learned?," Journal of Economic Literature, American Economic Association, vol. 35(3), pages 1243-1272, September.
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    Keywords

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    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • O0 - Economic Development, Innovation, Technological Change, and Growth - - General
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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