The Role of Intermediate Goods in International Monetary Cooperation

Abstract

This paper investigates the implication of intermediate goods on optimal monetary policy in open economies, and in particular, focusing on the welfare gains from monetary cooperation. In a relatively standard two-country dynamic stochastic general equilibrium model with input-output relations, I demonstrate that introducing intermediate goods can amplify the welfare gains caused by cost-push shocks by an order of magnitude larger. A detailed analysis on the equilibrium dynamics highlights a new channel that is absent in the previous literature: non-cooperative central banks respond differently to shocks in the intermediate goods market versus shocks in the final goods market, even if these shocks generate the same distortions when the two central banks cooperate. Furthermore, I find that increasing the degree of openness in the intermediate goods market can reduce the welfare gains from monetary cooperation. This casts doubt on whether the recent trend in international economic integration may justify the potential need for international monetary cooperation.