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Is there a Role for International Trade Costs in Monetary Policy?

34 Pages Posted: 17 Nov 2007 Last revised: 27 May 2010

Hakan Yilmazkuday

Florida International University (FIU) - Department of Economics

Date Written: May 26, 2010

Abstract

This paper develops an open-economy DSGE model to analyze the effects of international trade costs on monetary policy of open economies. The implications of this micro-founded New-Keynesian model are tested on a prototype small economy that is open to international trade costs shocks, Canada. When a utility-based expected loss function is considered, the central bank is found to be far from being optimal in its actions, independent of international trade costs. When an ad hoc expected loss function considering the volatilities in inflation, output and interest rate is considered, it is found that the actions of the central bank are explained best when international trade costs in fact exist but the central bank ignores them. Given the ad hoc loss function, the actions of the central bank are best explained when 70% of weight is assigned to inflation, 15% of weight to interest rate and 15% of weight to output.

Keywords: DSGE Model, Monetary Policy Rule, Trade Costs, Inflation Targeting, Canada

JEL Classification: E52, E58, F41

Suggested Citation

Yilmazkuday, Hakan, Is there a Role for International Trade Costs in Monetary Policy? (May 26, 2010). Available at SSRN: https://ssrn.com/abstract=1030624 or http://dx.doi.org/10.2139/ssrn.1030624

Hakan Yilmazkuday (Contact Author)

Florida International University (FIU) - Department of Economics ( email )

11200 SW 8th Street
Miami, FL 33199
United States

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