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Exchange Rates and Monetary Policy When Tradable and Nontradable Goods are Complements

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  • William Craighead

    (Department of Economics and Geosciences, US Air Force Academy)

Abstract

This paper examines the implications of complementarity between tradable and nontradable goods for exchange rates and monetary policy in a two-country general equilibrium model. In doing so, it revisits well-known findings in the New Open Economy Macroeconomics literature that exchange rates are proportional to national money supplies and that optimal monetary policies respond only to domestic shocks. These results depend on a number of simplifying assumptions, including a unitary elasticity of substitution between tradable and nontradable goods. When this assumption is replaced by a more-realistic one of complementarity, exchange rates depend on relative productivity in addition to money supplies when prices are flexible. When prices are sticky, complementarity amplifies the effect of relative money supplies on the exchange rate and creates additional spillover effects from changes of the foreign money supply on domestic consumption. With complementarity, optimal monetary policies respond to external as well as internal shocks.

Suggested Citation

  • William Craighead, 2021. "Exchange Rates and Monetary Policy When Tradable and Nontradable Goods are Complements," Working Papers 2021-01, Department of Economics and Geosciences, US Air Force Academy.
    • Handle: RePEc:ats:wpaper:wp2021-1
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    References listed on IDEAS

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    More about this item

    Keywords

    Complementarity; New Open Economy Macroeconomics; Exchange Rates; Monetary Policy; Nontradable Goods;
    All these keywords.

    JEL classification:

    • F42 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - International Policy Coordination and Transmission
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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