The Role of International Financial Integration in Monetary Policy Transmission

Motivated by empirical evidence, we propose an open-economy New Keynesian model that allows financial intermediaries to hold foreign long-term bonds. We find financial integration amplifies the effects of an expansionary domestic monetary policy shock and turns an expansionary foreign monetary shock into a sizable contraction. Among various features of our model, the bond duration plays a major role, and our results cannot be replicated by a standard model of perfect risk sharing between households. Finally, we observe an important interaction between financial integration and trade openness, and demonstrate trade alone does not have an economically meaningful impact on monetary policy transmission