Production Networks, Exchange Rates and Macroeconomic Stability

As cross-border production sharing and multi-country production networks expand to cover more countries and more goods and services, questions arise about their implications for stability and adjustment in the open macro-economy. Participation in a production network ties a country more closely to other members of that network, thereby reducing cross-border asymmetries and promoting cyclical convergence. This strengthens the case for monetary cooperation and currency integration. On the other hand, if network activities are confined to a narrow, but non-trivial part, of the economy, then cross-border convergence may come at the expense of rising asymmetries within the economy. Rising asymmetries may compromise the effectiveness of monetary and fiscal policies. When the standard open-economy macro model is amended to take account of production sharing, the consequences for policy efficacy are similar to those arising from greater capital mobility. Further, production sharing may enhance or diminish the case for cross-border policy coordination, depending on whether it is broadly based or narrowly confined to specific sectors and industries.