Does Trade Integration Alter Monetary Policy Transmission?

Posted: 25 Sep 2008

See all articles by Tobias J. Cwik

Tobias J. Cwik

Board of Governors of the Federal Reserve System

Gernot J. Müller

University of Tuebingen - Department of Economics

Maik H. Wolters

Kiel Institute for the World Economy - IFW

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Date Written: August 18, 2008

Abstract

This paper explores the role of trade integration - or openness - for monetary policy transmission in a medium-scale New Keynesian model. Allowing for strategic complementarities in price-setting, we highlight a new dimension of the exchange rate channel by which monetary policy directly impacts domestic inflation. Although the strength of this effect increases with economic openness, it also requires that import prices respond to exchange rate changes. In this case domestic producers find it optimal to adjust their prices to exchange rate changes which alter the domestic currency price of their foreign competitors. We pin down key parameters of the model by matching impulse responses obtained from a vector autoregression on U.S. time series relative to an aggregate of industrialized countries. While we find evidence for strong complementarities, exchange rate pass-through is limited. Openness has therefore little bearing on monetary transmission in the estimated model.

Keywords: Monetary Policy Transmission, Open Economy, Trade Integration, Exchange Rate Channel, Strategic Complementarity, Exchange Rate Pass-Through

JEL Classification: F41, F42, E52

Suggested Citation

Cwik, Tobias J. and Müller, Gernot J. and Wolters, Maik H., Does Trade Integration Alter Monetary Policy Transmission? (August 18, 2008). CFS Working Paper No. 2008/29. Available at SSRN: https://ssrn.com/abstract=1271910

Tobias J. Cwik

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue
Washington, DC 20551
United States

HOME PAGE: http://www.federalreserve.gov/econresdata/tobias-cwik.htm

Gernot J. Müller (Contact Author)

University of Tuebingen - Department of Economics ( email )

Mohlstrasse 36
D-72074 Tuebingen, 72074
Germany

Maik H. Wolters

Kiel Institute for the World Economy - IFW ( email )

United States

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