Asymmetries in an open economy
In this paper Fornaro and Romei develop a multi-country Keynesian model with multiple sectors. Their economy is composed of a continuum of small open economies. In each economy labor is used to produce a common tradable good as well a non-tradable one. There are also nominal wage rigidities. The authors study the response of the economy to a global reallocation shock, which leads to a temporary rise in consumers’ demand for the tradable good, relative to the non-tradable one. The shock is global, in the sense that it hits symmetrically every country in the world. They find that the dynamics of reallocation significantly differ when compared to a closed economy:
In open economies, the strength of the positive impact of a monetary expansion on aggregate demand depends on the degree of capital mobility. Under financial autarky, the aggregate demand effect is especially strong, because any increase in the production of tradable goods has to be consumed domestically. With free capital mobility, the aggregate demand effect is much weaker. The reason is that when the domestic production of tradable goods increases domestic agents consume only part of it. The rest is sold to foreign consumers, and the receipts are invested in foreign assets. This effect weakens the positive impact of a monetary expansion on demand for domestic non-traded goods, and worsens the trade-off between inflation and employment faced by national central banks. As a result, the monetary policy response to a reallocation shock is tighter under free capital mobility, compared to financial autarky. International financial integration thus mitigates the impact of a rise in global demand for tradable goods on inflation, but exacerbates its effect on unemployment.
Monetary policy during unbalanced global recoveries
Authors: Luca Fornaro, Federica Romei
From: Universitat Pompeu Fabra, University of Oxford
