Gains from International Monetary Policy Coordination: Does it Pay to Be Different?

55 Pages Posted: 26 Aug 2005

See all articles by Zheng Liu

Zheng Liu

Federal Reserve Banks - Federal Reserve Bank of San Francisco

Evi Pappa

London School of Economics & Political Science (LSE); Autonomous University of Barcelona - Department of Economics and Economic History

Date Written: August 2005

Abstract

This paper presents a new argument for international monetary policy coordination based on considerations of structural asymmetries across countries. In a two-country world with a traded and a non-traded sector in each country, optimal independent monetary policy cannot replicate the natural-rate allocations. There are potential welfare gains from coordination since the planner under a cooperating regime internalizes a terms-of-trade externality that independent central banks tend to overlook. Yet, with symmetric structures across countries, the gains are quantitatively small. If the size of the traded sector differs across countries, the gains can be sizable and increase with the degree of asymmetry. The planner's optimal policy not only internalizes the terms-of-trade externality, it also creates a terms-of-trade bias in favor the country with a larger traded sector. Further, the planner tries to balance the terms-of-trade bias against the need to stabilize fluctuations in the terms-of-trade gap.

Keywords: International Policy Coordination, Optimal Monetary Policy, Asymmetric Structures, Terms-of-Trade Bias

JEL Classification: E52, F41, F42

Suggested Citation

Liu, Zheng and Pappa, Paraskevi (Evi), Gains from International Monetary Policy Coordination: Does it Pay to Be Different? (August 2005). ECB Working Paper No. 514, Available at SSRN: https://ssrn.com/abstract=775425 or http://dx.doi.org/10.2139/ssrn.775425

Zheng Liu (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of San Francisco ( email )

101 Market Street
San Francisco, CA 94105
United States

Paraskevi (Evi) Pappa

London School of Economics & Political Science (LSE) ( email )

Houghton Street
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United Kingdom
+44 20 7955 7584 (Phone)
+44 20 7831 1840 (Fax)

Autonomous University of Barcelona - Department of Economics and Economic History ( email )

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Barcelona, 08193
Spain

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