Gains from Coordination in a Multi-Sector Open Economy: Does it Pay to Be Different?

IGIER Working Paper No. 296

48 Pages Posted: 18 Dec 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: January 2005

Abstract

Do countries gain by coordinating their monetary policies if they have different economic structures? We address this issue in the context of a new open-economy macro model with a traded and a non-traded sector and more importantly, with a across-country asymmetry in the size of the traded sector. We study optimal monetary policy under independent and cooperating central banks, based on analytical expressions for welfare objectives derived from quadratic approximations to individual preferences. In the presence of asymmetric structures, a new source of gains from coordination emerges due to a terms-of-trade externality. This externality affects unfavorably the country that is more exposed to trade and its effects tend to be overlooked when national central banks act independently. The welfare gains from coordination are sizable and increase with the degree of asymmetry across countries and the degree of openness, and decrease with the within-country correlation of sectoral shocks.

Keywords: Optimal Monetary Policy, International Policy Coordination, Multiple Sectors, Asymmetric Structures, Sticky Prices

JEL Classification: E52, F41, F42

Suggested Citation

Liu, Zheng and Pappa, Paraskevi (Evi), Gains from Coordination in a Multi-Sector Open Economy: Does it Pay to Be Different? (January 2005). IGIER Working Paper No. 296, Available at SSRN: https://ssrn.com/abstract=870787 or http://dx.doi.org/10.2139/ssrn.870787

Zheng Liu

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

101 Market Street
San Francisco, CA 94105
United States

Paraskevi (Evi) Pappa (Contact Author)

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

Houghton Street
London WC2A 2AE
United Kingdom
+44 20 7955 7584 (Phone)
+44 20 7831 1840 (Fax)

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

Edifici B - Campus Bellaterra
Barcelona, 08193
Spain

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