Monetary Policy and Trade Globalization

This working paper was written by Dudley Cooke (Trinity College Dublin and Hong Kong Institute for Monetary Research).I develop a two country general equilibrium model with heterogeneous price-setting firms to understand how shocks to monetary policy and aggregate labor productivity impact trade integration, which I capture through the (inverse) average productivity of exporting firms. A contractionary domestic monetary policy shock raises the average productivity of domestic exporting firms but lowers the average productivity of foreign exporting firms. The magnitude of these changes is greater when governments target domestic price inflation as opposed to consumer price inflation. A positive shock to domestic labor productivity generates positive - although quantitatively small - changes in the average productivity of all exporting firms when consumer price inflation is targeted. When domestic price inflation is targeted, the same shock causes a fall in the average productivity of domestic exporting firms, and a far larger rise in the productivity of foreign exporting firms