Good Policies or Good Luck? New Insights on Globalization and the International Monetary Policy Transmission Mechanism

62 Pages Posted: 24 Jul 2017 Last revised: 29 Apr 2020

See all articles by Enrique Martínez-García

Enrique Martínez-García

Federal Reserve Bank of Dallas - Research Department

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Date Written: July, 2017

Abstract

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, 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, I show that 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 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 the theoretical predictions of the workhorse open-economy New Keynesian model are largely consistent with the stylized facts of the globalization era started in the 1960s and the Great Moderation period that followed.

JEL Classification: C11, C13, F41

Suggested Citation

Martinez-Garcia, Enrique, Good Policies or Good Luck? New Insights on Globalization and the International Monetary Policy Transmission Mechanism (July, 2017). Globalization and Monetary Policy Institute Working Paper No. 321, Available at SSRN: https://ssrn.com/abstract=3006524 or http://dx.doi.org/10.24149/gwp321

Enrique Martinez-Garcia (Contact Author)

Federal Reserve Bank of Dallas - Research Department ( email )

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