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The B.E. Journal of Macroeconomics

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Optimal monetary policy in a model of vertical production and trade with reference currency

Liutang Gong / Chan Wang
  • Corresponding author
  • Central University of Finance and Economics, School of Finance, Beijing, China
  • Peking University, Guanghua School of Management, Beijing Shi, China
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/ Heng-Fu Zou
  • Central University of Finance and Economics, China Economics and Management Academy, Beijing, China
  • Wuhan University, Institute for Advanced Study, Beijing, China
  • Shenzhen University, Institute for Advanced Study, Beijing, China
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Published Online: 2018-10-09 | DOI: https://doi.org/10.1515/bejm-2014-0148

Abstract

This paper examines optimal monetary policy rules in a model of vertical production and trade with reference currency. As evidenced by empirical findings, we assume that final-goods prices are sticky, but intermediate-goods prices are flexible. We find that even if intermediate-goods prices are flexible, monetary authorities need to respond to the shocks at the stage of intermediate-goods production. We also find that, when a shock occurs at the stage of final-goods production, monetary responses are independent of the expenditure share of final-goods producers on intermediate goods. For the first time in the literature, our model gives a condition under which both countries are willing to participate in monetary cooperation. Thus the gains from cooperation are real. In addition, we compare the volatility of the nominal exchange rate in Nash case with that in cooperative case, and compare the volatility of the nominal exchange rate in our model with that in a model without vertical production and trade as well. We also extend the model to consider a case of dual price stickiness. We find that the change in solution methods completely alters the conclusions of the model.

Keywords: exchange rates; monetary cooperation; optimal monetary policy; reference-currency pricing; vertical production and trade

JEL Classification: E5; F3; F4

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About the article

Published Online: 2018-10-09


Citation Information: The B.E. Journal of Macroeconomics, 20140148, ISSN (Online) 1935-1690, DOI: https://doi.org/10.1515/bejm-2014-0148.

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