Working Paper: NBER ID: w25765
Authors: Paul R. Bergin; Giancarlo Corsetti
Abstract: Motivated by the long-standing debate on the pros and cons of competitive devaluation, we propose a new perspective on how monetary and exchange rate policies can contribute to a country’s international competitiveness. We refocus the analysis on the implications of monetary stabilization for a country’s comparative advantage. We develop a two-country New-Keynesian model allowing for sectoral differences in the production of tradables in each economy: while in one sector firms are perfectly competitive, in another sector firms produce differentiated goods under monopolistic competition and subject to nominal rigidities, hence their performance is more sensitive to macroeconomic uncertainty. We show that, by stabilizing inflation and the output gap, monetary policy can foster the competitiveness of these firms, encouraging investment and entry in the differentiated goods sector, and ultimately affecting the composition of domestic output and exports. Welfare implications of alternative monetary policy rules that shift comparative advantage are found to be substantial in a calibrated version of the model.
Keywords: Monetary Policy; Exchange Rate; Comparative Advantage; New Keynesian Model
JEL Codes: F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| effective monetary policy (E52) | competitiveness of firms in the differentiated goods sector (L13) |
| stabilizing inflation and output gap (E63) | competitiveness of firms in the differentiated goods sector (L13) |
| optimal monetary policy (E63) | lower prices for differentiated goods (D43) |
| lower prices for differentiated goods (D43) | improved competitiveness in domestic and international markets (F23) |
| shift to unilateral exchange rate peg (F31) | loss in production and export share of differentiated goods in the pegging country (F14) |
| shift to unilateral exchange rate peg (F31) | increase in production and export share of differentiated goods in the country maintaining efficient stabilization (F14) |
| shift to unilateral exchange rate peg (F31) | drop in number of firms in the differentiated goods sector in the pegging country (F12) |
| drop in number of firms in the differentiated goods sector in the pegging country (F12) | significant welfare implications (I30) |