Good Policies or Good Luck? New Insights on Globalization and the International Monetary Policy Transmission Mechanism
63 Pages Posted: 6 Jul 2017
Date Written: July 3, 2017
The open-economy dimension is central to the discussion of the trade-offs that monetary policy faces in an increasingly integrated world. I investigate the monetary policy transmission mechanism in a two-country workhorse New Keynesian model where policy is set according to Taylor (1993) rules. I find that a common monetary policy isolates the effects of trade openness on the cross-country dispersion alone, and that the establishment of a currency union as a means of deepening economic integration may lead to indeterminacy. I argue that the common (coordinated) monetary policy equilibrium is the relevant benchmark for policy analysis showing that in that case open economies tend to experience lower macro volatility, a flatter Phillips curve, and more accentuated trade-offs between inflation and slack. Moreover, the trade elasticity often magnifies the effects of trade integration (globalization) beyond what conventional measures of trade openness would imply. I also discuss how other features such as the impact of a common and stronger anti-inflation bias, technological diffusion across countries, and the sensitivity of labor supply to real wages influence the quantitative effects of policy and openness in this context. Finally, I conclude that these theoretical predictions are largely consistent with the stylized facts of the Great Moderation.
Keywords: New Open Economy Macroeconomics, International Monetary Policy Coordination, Trade Openness, Flattening of the Phillips Curve, Great Moderation.
JEL Classification: C11, C13, F41
Suggested Citation: Suggested Citation