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Federal Reserve Bank of Dallas
Globalization Institute Working Papers
Good Policies or Good Luck? New Insights on Globalization and the International Monetary Policy Transmission Mechanism
Enrique Martinez-Garcia
Abstract

The open-economy dimension is central to the discussion of the trade-offs that monetary policy faces in an increasingly integrated world. I investigate the monetary policy transmission mechanism in a two-country workhorse New Keynesian model where policy is set according to Taylor (1993) rules. I find that a common monetary policy isolates the effects of trade openness on the cross-country dispersion, and that the establishment of a currency union as a means of deepening economic integration may lead to indeterminacy. I argue that the common (coordinated) monetary policy equilibrium is the relevant benchmark for policy analysis showing that in that case open economies tend to experience lower macro volatility, a flatter Phillips curve, and more accentuated trade-offs between inflation and slack. Moreover, I show that the trade elasticity often magnifies the effects of trade integration (globalization) beyond what conventional measures of trade openness would imply. I also discuss how other features such as the impact of a stronger anti-inflation bias, technological diffusion across countries, and the sensitivity of labor supply to real wages influence the quantitative effects of policy and openness in this context. Finally, I conclude that the theoretical predictions of the workhorse open-economy New Keynesian model are largely consistent with the stylized facts of the globalization era started in the 1960s and the Great Moderation period that followed.


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Enrique Martinez-Garcia, Good Policies or Good Luck? New Insights on Globalization and the International Monetary Policy Transmission Mechanism, Federal Reserve Bank of Dallas, Globalization Institute Working Papers 321, 01 Jul 2017.
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DOI: 10.24149/gwp321
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