Trade, Unemployment, and Monetary Policy

69 Pages Posted: 29 Jun 2020

Multiple version iconThere are 2 versions of this paper

Date Written: June 2020

Abstract

We study how trade linkages affect the conduct of monetary policy in a two-country model with heterogeneous firms, endogenous producer entry, and labor market frictions. We show that the ability of the model to replicate key empirical regularities following trade integration---synchronization of business cycles across trading partners and reallocation of market shares toward more productive firms---is central to understanding how trade costs affect monetary policy trade-offs. First, productivity gains through firm selection reduce the need of positive inflation to correct long-run distortions. As a result, lower trade costs reduce the optimal average inflation rate. Second, as stronger trade linkages increase business cycle synchronization, country-specific shocks have more global consequences. Thus, the optimal stabilization policy remains inward looking. By contrast, sub-optimal, inward-looking stabilization---for instance too narrow a focus on price stability---results in larger welfare costs when trade linkages are strong due to inefficient fluctuations in cross-country aggregate demand.

Keywords: Optimal monetary policy, trade integration

JEL Classification: E24, E32, E52, F16, F41, J64

Suggested Citation

Cacciatore, Matteo and Ghironi, Fabio Pietro, Trade, Unemployment, and Monetary Policy (June 2020). CEPR Discussion Paper No. DP14952, Available at SSRN: https://ssrn.com/abstract=3638057

Matteo Cacciatore (Contact Author)

HEC Montreal ( email )

No Address Available

Fabio Pietro Ghironi

University of Washington ( email )

Department of Economics
Box 353330
Seattle, WA 98195-3330
United States
206-543-5795 (Phone)

HOME PAGE: http://faculty.washington.edu/ghiro

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