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Optimal monetary policy with international trade in intermediate inputs

Author

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  • Gong, Liutang
  • Wang, Chan
  • Zou, Heng-fu
Abstract
This paper examines optimal monetary policy in a two-country New Keynesian model with international trade in intermediate inputs. We derive the loss function of a cooperative monetary policymaker and find that the optimal monetary policy must target intermediate-goods price inflation rates, final-goods price inflation rates, final-goods output gaps, and relative-price gaps. We use the welfare loss under the optimal monetary policy as a benchmark to evaluate the welfare implications of three Taylor-type monetary policy rules. A main finding is that the degree of price stickiness at the stage of intermediate-goods production is a key factor to determine which policy rule should be followed. Specifically, when the degree of price stickiness at the stage of intermediate-goods production is high, the policymaker should follow intermediate-goods PPI-based Taylor rule, whereas CPI-based Taylor rule should be followed when the degree of price stickiness at the stage of intermediate-goods production is intermediate or low.

Suggested Citation

  • Gong, Liutang & Wang, Chan & Zou, Heng-fu, 2016. "Optimal monetary policy with international trade in intermediate inputs," Journal of International Money and Finance, Elsevier, vol. 65(C), pages 140-165.
    • Handle: RePEc:eee:jimfin:v:65:y:2016:i:c:p:140-165
    DOI: 10.1016/j.jimonfin.2016.03.007
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    7. William D. Craighead, 2020. "Intermediate Goods and Exchange Rate Disconnect," Open Economies Review, Springer, vol. 31(1), pages 113-129, February.
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    9. Jingjing Fan & Feng Shi & Junzhu Zhao & Jingming Zhu, 2023. "Trade Policy Uncertainty, Financial Frictions, and Monetary Policy," Annals of Economics and Finance, Society for AEF, vol. 24(1), pages 193-211, May.
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    More about this item

    Keywords

    Vertical production and trade; Optimal monetary policy; Inflation targeting; Welfare;
    All these keywords.

    JEL classification:

    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
    • F3 - International Economics - - International Finance
    • F4 - International Economics - - Macroeconomic Aspects of International Trade and Finance

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