International relocation and the effects of monetary policy in a three-country model with nominal rigidities

Transcription

1 Tezukayama RIE Discussion Paper Series No. 4 Inernaional relocaion and he effecs of moneary policy in a hree-counry model wih nominal rigidiies Waaru Johdo Faculy of Economics, Tezukayama Universiy April 5 Tezukayama Universiy Research Insiue for Economics and usiness 7-- Tezukayama, Nara 63-85, Japan

2 Inernaional relocaion and he effecs of moneary policy in a hree-counry model wih nominal rigidiies Waaru Johdo * Tezukayama Universiy April 5 Absrac This paper exends he new open economy macroeconomics model of Corsei e al. () o include inernaional relocaion of firms, and explores he effecs of moneary expansion by each counry on he exchange raes, inernaional relocaion, and relaive consumpion levels. The paper shows a new inernaional ransmission mechanism: he exchange rae depreciaion induced by moneary expansion in one of he hree counries (regardless of he source of he expansion) causes foreign firms o relocae o ha counry, and consequenly raises he relaive consumpion level of ha counry. In conras, he moneary expansion can be derimenal o oher counries. JEL classificaion codes: E5; F; F3; F4 * Waaru Johdo, Deparmen of Economics,Tezukayama Universiy, 7--, Tezukayama, Nara 63-85, Japan. Tel.: ; fax: address: johdo@ezukayama-u.ac.jp

3 . Inroducion In he new open economy macroeconomics (hereafer, NOE) lieraure, a number of sudies have focused on how he macroeconomic aciviy of each counry and he exchange rae are influenced by moneary policy shocks under monopolisic disorions and price rigidiies (see, e.g., Obsfeld and Rogoff, 995 and, Lane, 997, es and Devereux, a and b, Hau,, ergin and Feensra,, Corsei and Peseni, and 5, Cavallo and Ghironi,, Devereux and Engel,, Kollmann, and, and Smes and Wouhers, ). The benchmark model of Obsfeld and Rogoff (995) shows ha a domesic moneary expansion raises foreign and domesic oupu and welfare hrough he firs-order effec of increasing world consumpion. However, mos NOE models have assumed ha firms are immobile across counries. Alhough i is feasible o explore he effecs of a moneary policy shock in his framework under he assumpion of a fixed inernaional disribuion of firms, recen empirical evidence suggess ha exchange raes affec he producion locaions of firms and heir foreign direc invesmens (see, e.g., Cushman, 985 and 988, Froo and Sein, 99, Campa, 993, Klein and Rosengren, 994, Goldberg and Kolsad, 995, lonigen, 997, Goldberg and Klein, 998, énassy-quéré e al,, Chakrabari and Scholnick,, and Farrell e al., 4). For example, Campbell and Lapham (4) find ha exchange rae movemens have a significan effec on he relocaion of esablishmens in U.S. reail rade indusries locaed near he U.S.-Canada border. In Oher relaed references include enigno (), Engel (), Warnock (3), Devereux (4), Andersen and eier (5), Suherland (5), Tille (8), Johdo (3), and Sousa (3). For a survey of he lieraure examining deerminans of foreign direc invesmen, see lonigen (5).

4 addiion, in recen years, he enry regulaions governing mulinaional firms in developed (e.g., Japan, Souh Korea, he US, and he European Union) and newly emerging (e.g., China, ASEAN, India, Russia, exico and razil) counries alike have been subsanially liberalized. As a resul, mulinaional firms from he US, Japan, Souh Korea, and China have very acively invesed across naional borders. However, lile aenion has been paid in he NOE lieraure o he relaionship beween inernaional relocaion of firms and macroeconomic variables, including consumpion and he exchange rae. The excepion is Johdo (5), who presens a NOE model wih inernaional relocaion of firms. 3 In his lieraure, Johdo (5) conrass a wo-counry NOE model wihou inernaional relocaion wih a NOE model wih inernaional relocaion, and succeeds in showing explicily he effecs of one counry s moneary expansion on he exchange rae and consumpion of each counry, leading o firm relocaion o he oher counry. However, because Johdo (5) begins wih he assumpion of a wo-counry economy, he canno consider how allowing for a hird counry affecs he impacs of a moneary expansion on inernaional relocaion of firms and oher macroeconomic variables, including consumpion and he exchange rae. Recenly, mulinaional firms have very acively invesed across naional borders: American, Japanese and China s mulinaional firms are increasingly making heir way ino each oher s markes. I is, herefore, appropriae ha a mulicounry model be adoped o examine how allowing for inernaional 3 Aizenman (994), Devereux and Engel (), Cavallari (4, 5) and Chu (5) all consider (opimal) moneary policy in a represenaive firm framework wih horizonal foreign direc invesmen, bu do no allow for he endogenous relocaion of firms. 3

5 relocaion of firms affecs he impacs of a moneary expansion on consumpion and exchange raes. Given his moivaion, his paper invesigaes he impacs of moneary shocks on he inernaional disribuion of firms, he exchange rae, and consumpion by generalizing he hree-counry model of Corsei e al. () o include inernaional relocaion of firms. In paricular, a novel feaure of our model is ha he inernaional disribuion of firms responds o exchange rae movemens as in Johdo (5). 4 This implies ha our model generaes a new inernaional ransmission effec ha operaes hrough he inernaional relocaion of firms, which has been overlooked by he benchmark model of Corsei e al. (). In his analysis, we show ha he exchange rae depreciaion induced by a moneary expansion in one of hree counries (regardless of he source of he expansion) causes firms whose producion sies are abroad o relocae o ha counry, which raises he relaive consumpion of ha counry. This is because he relocaion increases labor demand in ha counry, which in urn raises labor income. In conras, he moneary expansion can be derimenal o oher counries, in erms of relaive consumpion level. This is because oher counries experience he opposie response o he firm relocaion and exchange rae adjusmen. The remainder of his paper is srucured as follows. Secion oulines he feaures of he model. Secion 3 describes he equilibrium. In Secions 4 and 5, we examine he impacs of moneary policy shocks on he inernaional disribuion of firms across he 4 Recenly empirical evidence shows ha he number of firms is reacing o moneary policy shocks (see e.g., ergin and Corsei, 6). 4

6 hree counries, he exchange rae, and relaive consumpion levels. The final secion summarizes he findings and concludes he paper.. The model In his secion, we consruc a perfec-foresigh, hree-counry model wih inernaional relocaion of firms. This model is similar o he one presened by Johdo (4), in which here are wo counries in he world economy: home counry and foreign counry. In our model, he economy consiss of hree counries and hey are denoed by A, and C, respecively. The size of he world populaion is normalized o uniy, and households in counries A and inhabi he inervals [, /3] and (/3, /3], respecively, and hose in counry C inhabi he inerval (/3, ]. Therefore, he shares of households in A,, and C are /3, /3, and /3, respecively. There is monopolisic compeiion in he markes for goods and labor, whereas he markes for money and inernaional bonds are perfecly compeiive. On he producion side, monopolisically compeiive producers exis coninuously in he range [, ], each of which produces a single differeniaed produc ha is freely radable. In his model, counry A consiss of hose producers in he inerval [, n ], counry consiss of hose producers in he inerval [n, m ], and he remaining [m, ] producers are in counry C, where n and m are endogenous variables. Finally, we assume ha firms are mobile inernaionally bu heir owners are no... Households 5

7 The ineremporal objecive funcion of represenaive household x in counry h a ime, wih h = A,, C, is: U h (x) = = β (logc h (x) + χlog( h (x)/p h ) (κ/)(l sh (x)) ), () where < β < is a consan subjecive discoun facor; C h (x) is he consumpion index ha is defined laer; h (x)/p h is real money holdings, where h (x) denoes nominal money balances held a he beginning of period +, and P h is he consumpion price index of counry h; and l sh (x) is he amoun of labor supplied by household x. A each poin in ime, households receive reurns on risk-free real bonds, earn wage income by supplying labor, and receive profis from all firms equally. 5 Therefore, a ypical household in counry h faces he following budge consrain: E h h +(x)+ h (x) = (+i )E h h (x)+ h (x)+w h (x)l sh (x)p h C h (x)p h τ h + ((E h /E A n ) Π A m (z)dz+(e h /E ) Π n (z)dz+e h C Π (z)dz), () m where E h denoes he nominal exchange rae, defined as counry h s currency per uni of counry C s currency (so ha E C = ); h +(x) denoes he nominal bond denominaed in he counry C s currency held by counry h s agen x in period + ; i denoes he nominal yield on he bond in erms of he counry C s currency; W h (x)l sh (x) is nominal labor income, where W h (x) denoes he nominal wage rae of labor supplied by 5 In a relaed wo-counry monopolisic rade model, Corsei e al (5) posi ha each home and foreign household receives an equal share of profis of all firms. In conras, Devereux and Engel (), Cavallari (4), Ghironi and eliz (5), Lubik and Russ (6), and Russ (7) posi ha each household only owns domesic firms in all hese models. 6

8 n household x in period ; Π A m (z)dz, Π n (z)dz, and Π C (z)dz represen he oal m nominal profi flows of firms locaed in counries A,, and C, respecively; P h C h (x) represens nominal consumpion expendiure; and τ h denoes real lump-sum ransfers from he governmen in period. Noe ha all variables in () are measured in per capia erms. In he governmen secor, we assume ha governmen spending is zero and ha all seignorage revenues derived from prining he naional currency are rebaed o he public in he form of lump-sum ransfers. Hence, he governmen budge consrain in counry h is = s h τ h + [( h h )/P h ], where h is aggregae money supply and s h = /3 denoes he populaion share of counry h in he world populaion. Here, we assume ha any monopolisically compeiive firm ha operaes in every counry employs he same producion echnology. In counry A, firm z [, n ] hires a coninuum of differeniaed labor inpus domesically and produces a unique produc in a single locaion according o he CES producion funcion: 3 y A (z) = ((/3) /φ l ( z,x) A (φ )/φ dx) φ/(φ ), (3) where y A (z) denoes he producion of firm z in period ; l A (z, x) is he firm z s inpu of labor from household x in period ; and φ > is he elasiciy of inpu subsiuion. Given he firm s cos minimizaion problem, firm z s opimal demand funcion for labor x is as follows: l A (z, x) = s A (W A (z)/w A ) φ y A (z), (4) 7

9 3 where W A ((/3) W A ( x) ( φ) dx) /( φ) is a price index for labor inpu. Similarly, he oher counries firms have an opimal demand funcion for labor x ha is analogous o equaion (4).... Definiion of consumpion baske The consumpion baske of household x living in counry h a period is: C h n ( θ) / θ m ( ) / ( ) h h θ θ h x c ( z, x) dz + c ( z, x) dz + c ( z, x) = A n m C ( θ) / θ dz θ ( θ), (5) where θ > is he elasiciy of subsiuion among varieies produced wihin each counry; and c h j(z, x) denoes consumpion by household x locaed in counry h of he good produced by firm z locaed in counry j. From (5), he consumpion-based price index is defined as: [ ] P h n h = ( P A ( z) θ [ ] m h dz + P ( z) n θ [ ] θ h dz + ( z) m P dz) /(θ), where P h j(z) is he price in counry h of he good produced by firm z in counry j, j = A,, C. C... Household decisions Households maximize he consumpion index C h (x) subjec o a given level of expendiure by opimally allocaing differeniaed goods produced in he hree counries c h j(z, x), j = A,, C. From his problem, we obain he following privae demand funcions: 8

10 C h j(z, x) = (P h j(z)/p h ) θ C h (x), j = A,, C. (6) Summing he above demand funcions and equaing he resuling equaion o he produc of firm z locaed in counry j yields he following marke-clearing condiion for any produc z produced in counry j: y j (z) = (P A j(z)/p A ) θ C A + (P j(z)/p ) θ C + (P C j(z)/p C ) θ C C, j = A,, C, (7) where C A = 3 C A ( x)dx 3 3, C = C ( x)dx, and C C = C C ( x)dx. From he law of one price and he purchasing power pariy arising from symmeric preferences, (7) is rewrien as: 3 y j (z) = (P j j(z)/p j ) θ C w, j = A,, C, (8) where C w C A + C + C C. In he second sage, households maximize () subjec o (). The firs-order condiions for his problem wih respec o h +(x) and h (x) can be wrien as: C h +(x) = βc h (x)( + i + )[(P h /E h )/(P h +/E h +)], (9) h (x)/p = χc h (x)[( + i h +)E h +/(( + i h +)E h + E h )], () where i + is he nominal ineres rae for counry C s currency loans beween periods and +, defined as usual by + i + = (P C +/P C )( + r + ), and where r + denoes he real ineres rae. Equaion (9) is he Euler equaion for consumpion, and () is he one for money demand. Following Corsei and Peseni (), we inroduce nominal rigidiies ino he model 9

11 in he form of one-period wage conracs under which nominal wages in period are predeermined a he end of period. In he monopolisic labor marke, each household provides a single variey of labor inpu o a coninuum of domesic firms. Hence, in counry A, he equilibrium labor-marke condiions imply ha l sa (x) = n l A ( z,x)dz, x [, /3], where he lef-hand side represens he amoun of labor supplied by household x, and he righ-hand side represens firms oal demand for labor x. y aking W A, P A, and n as given, subsiuing l sa (x) = l A ( z,x)dz and equaion (4) ino he budge consrain given by (), and maximizing he lifeime uiliy given by () wih respec o he nominal wage rae W A (x), we obain he following firs-order condiion for he opimal nominal wage rae, W A (x): n κl sa (x) φ(w A (x)/p A ) = (φ)(l sa (x)/c A ). () The righ-hand side of () represens he marginal consumpion uiliy of addiional labor income resuling from a decrease in he nominal wage rae. This erm is posiive because φ >. The lef-hand side represens he marginal disuiliy of an associaed increase in labor effor. Hence, each monopolisically compeiive household uses () o se is wage rae. The labor suppliers of counries and C have analogous opimal wage condiions... Firm s decision Since he counry A-locaed firm z hires labor domesically, given W A, P A A, and P A, n, (3), and subjec o (8), he counry A-locaed firm z faces he following profi-maximizaion problem:

12 max Π A (z) = P A 3 A A(z)y A (z) W ( z) ( z, x) A P A A ( z ) l A dx = (P A A(z) W A )y A (z), subjec o y A (z) = (P A A(z)/P A ) θ C w. Given he above, he price mark-up is chosen according o: P A A(z) = (θ/(θ ))W A. () Since W A is given, () yields P A A(z) = P A A, z [, n ]. These relaionships imply ha each firm locaed in counry A supplies he same quaniy of goods. Similarly, oher firms locaed in differen counry have he price mark-up ha is analogous o equaion (). Denoing he maximized real profi flows of counry j-locaed firms by Π j (x)/p j, and subsiuing (8) and () ino Π j yields: Π j (z)/p j = (/θ)(p j j(z)/p j ) θ C w, j = A,,C. (3).3. Relocaion behavior We assume ha he driving force for relocaion o oher counries is differences in curren real profis beween wo counries. 6 In addiion, following he formulaion in Johdo (5), we assume ha all firms are no allowed o relocae insananeously even if here is he profi gap. A each poin in ime, his adjusmen mechanism for relocaion beween counries A and is formulaed as follows: 6 In he lieraure on mulinaional firms, Helpman e al. (4) and Eckel and Egger (9) derive he share of mulinaional firms endogenously by using his ype of profi differenial beween exporing and mulinaional aciviy.

13 n n = γ[π A (z)/p A Π (z)/p ] = γ[π A (z)/p A (E A /E )Π (z)/p A ]. (4) Analogously, he adjusmen mechanism for relocaion beween counries and C is formulaed as follows: m m = γ[π (z)/p Π C (z)/p C ] = γ[π (z)/p E Π C (z)/p ], (5) where γ ( γ < ) is a consan posiive parameer ha deermine he degree of firm mobiliy beween wo counries: a larger value of γ implies higher firm mobiliy beween counries. Inuiively, he parameer γ reflecs he coss falling on mobile firms in heir new locaions. Examples include he coss of finding appropriae plans, raining he local workforce, and adaping o he local legal sysem. ecause of hese coss, firms canno move insananeously o a beer locaion even if a profi gap beween wo counries provides he moivaion. As we explain in Secion 4, his relocaion adjusmen makes our inernaional ransmission mechanism differ crucially from hose in models in which he inernaional allocaion of firms is fixed arke condiions The equilibrium condiion for he inegraed inernaional bond marke is given by: 3 A ( x)dx ( x)dx + C ( x)dx =. (6) 3 This means ha he ne supply of bonds worldwide is zero. In addiion, he money markes are assumed always o clear in all counries, so ha he equilibrium condiions 7 y using a closed economy model wih firm enry, ergin and Corsei (6) show numerically ha here is some persisence in he effec of moneary expansion on enry of firms.

14 are given by A = 3 A ( x)dx 3 3, = ( x)dx, and C = C ( x)dx, 3 respecively. 3. Seady sae values In his secion, we derive he soluion for a symmeric seady sae in which all variables are consan, iniial ne foreign asses are zero ( h = ), h = A,, C. Henceforh, we denoe he seady-sae values by using he subscrip ss. In he symmeric seady sae, given he Euler equaion for consumpion (equaion (9)), he consan real ineres rae is given by: r ss = ( β)/β δ, (7) where δ is he rae of ime preference. ecause symmery, which implies C h ss = C w ss, holds, he seady-sae spaial allocaions of firms are: n ss = /3, (8) m ss = /3. (9) The seady sae oupu levels are: y hss = l sh ss = C h ss = C w ss = ((φ)/φ) / ((θ )/θ) / (/κ) /, h = A,, C. () Equaion () shows ha no only do all firms worldwide produce he same amoun of oupu, i also shows ha all households worldwide consume his oupu and supply he labor required o produce his oupu. Subsiuing C w ss from equaion () ino equaion 3

15 (3) yields he following seady-sae levels of real profi flows of counry j-locaed firms, which are equal: Π jss /P j ss = (/θ)((φ)/φ) / ((θ )/θ) / (/κ) /, j = A,, C. () From equaions (), (7), and (), he real balances of counry h agens are idenical in he seady sae: h ss/p h ss = χ((+δ)/δ)((φ)/φ) / ((θ )/θ) / (/κ) /, h = A,, C. () From hese money demand equaions, and given PPP, he seady-sae nominal exchange raes are deermined by he raio of h ss o C ss; i.e., E h ss = h ss/ C ss, h = A,, C. 4. A log-linearized analysis To examine he macroeconomic effecs of an unanicipaed permanen moneary policy shock, we solve a log-linear approximaion of he sysem around he iniial, zero-shock seady sae wih h ss, =, h = A,, C, as derived in he previous secion. For any variable X, we use X o denoe shor-run percenage deviaions from he iniial seady-sae value, i.e., X = dx X ss,, where X ss, is he iniial, zero-shock seady-sae value, and subscrip denoes he period in which he shock akes place. These shor-run percenage deviaions are consisen wih he lengh of nominal wage W = P z = h j conracs. Thus, nominal wages and goods prices can be deermined as ( ) h, j = A,, C, in he shor-run log-linearized equaions. In addiion, we use X o denoe long-run percenage deviaions from he iniial seady-sae value, i.e., j, 4

16 X = dx X = dx X, which is consisen wih flexible nominal wages. Noe ss, ss ss, ha X = X ss because he new seady sae is reached a period. y log-linearizing equaions (4) and (5) around he symmeric seady sae and z = P j j seing ( ), j = A,, C, we obain he following log-linearized expressions for he inernaional disribuion of firms: n m (( φ ) φ) ( θ ) A ( θ) ( κ) ( Ê Ê ) 3 = 3 γ, (3) ( 3γ )( ( φ ) φ) (( θ ) θ) 3 ( κ) Ê =. (4) Equaion (3) shows ha under a given E, an exchange rae depreciaion of counry A s currency ( E A E > ) induces relocaion of firms locaed in counry owards he counry A. 8 Inuiively, wih fixed nominal wages, which cause nominal produc prices o be sicky because of mark-up pricing by monopolisic produc suppliers, he depreciaion in counry A s currency increases relaive producion of counry A s goods A A hrough he expendiure-swiching effec ; i.e., y y = θ( E E ). 9 This increases he relaive profis of counry A-locaed firms, and consequenly, firms locaed in counry relocae o he counry A. Equaion (3) also shows ha nominal exchange rae changes have greaer effecs he greaer is he flexibiliy of relocaion (he larger is 8 This resul is consisen wih he evidence found in he empirical lieraure on he relaionship beween exchange raes and FDI (e.g., Cushman, 988, Caves, 989, Froo and Sein, 99, Campa, 993, Klein and Rosengren, 994, lonigen, 997, Goldberg and Klein, 998, énassy-quéré e al,, Chakrabari and Scholnick,, Kiyoa and Uraa, 4, and olling e al, 7). 9 The expendiure-swiching effec arises inuiively because exchange rae depreciaion causes a decrease in he relaive real price of counry A s goods for households in all counries so ha world consumpion demand swiches oward counry A s goods. Corsei e al (5) also define his as compeiive effec. 5

17 γ). y conras, when relocaion coss are high (γ = ), nominal exchange rae changes have a negligible effec on he relocaion of firms. The inuiion behind he impac of E in equaion (4) on he inernaional relocaion of firms beween counries and C can be explained analogously. 5. oneary policy shocks Now, we consider he effecs of an unanicipaed permanen moneary policy shock in each counry. 5.. The case of A A = >, C C = = = = In his subsecion, we focus on he impacs of a permanen moneary shock in counry A: A A = >. In his case, he closed-form soluions for he six key variables are as follows: A A E E = >, (5) ( ) ( ) A E = >, (6) ( ) ( ) 3 A n = γθ >, (7) ( ) ( ) ( 3 ) A m = γ θ >, (8) ( ) ( ) 6

18 ( A E E ) A A A C C = = >, (9) ( ) ( ) A ( Ê Ê ) + Ê > A C Ĉ Ĉ =, (3) where ( 6γθ + θ)( + 6γθ + θ) ( + 6γθ + θ) 9γ ~ 9γ θ ~ = δ + θ θ + >, (3) θ ~ 6 γθθ = δ <, (3) ( + 6γθ + θ) 9γ θ ~ ~ = + θ, (33) ( θ ) + 6γθ θ > ~ = γθ θ, (34) 3 < (( φ ) φ) (( θ ) θ) 3 ( κ) θ, (35) = > ~ δ ~ ( + δ) δ, θ ( θ ) θ, φ ( φ ) φ ~. Equaions (5) and (6) indicae ha an unanicipaed moneary expansion in counry A leads o exchange rae depreciaion in E A E and E. Equaion (7) shows ha an unanicipaed moneary expansion in counry A causes counry s firms o relocae o counry A. Equaion (8) shows ha an unanicipaed moneary expansion in counry A causes counry C s firms o relocae o counry. Equaions (9) and (3) show ha he relaive consumpion levels of counry A rise when here is an unanicipaed moneary expansion in counry A. The resuls (5), (7), and (9) can be explained inuiively as 7

19 follows. An unanicipaed moneary expansion in counry A requires an insananeous depreciaion of is currency o resore money marke equilibrium for a given level of iniial relaive consumpion. Under a given E, his hen leads o a reducion in he real price of counry A s goods relaive o counry s goods because of he depreciaion of counry A s currency (see equaion (5)), which causes world demand o swich from counry s goods o counry A s goods. Hereafer, we shall call his he expendiure-swiching effec. This demand shif increases he relaive profis of firms locaed in counry A, which causes firms locaed in counry o relocae o counry A. Hereafer, we shall call his he relocaion effec (see equaion (7)). As a resul, he relocaion raises he relaive labor income of counry A, which raises he relaive consumpion of counry A (see equaion (9)). On he oher hand, he resuls (6), (8), and (3) can be explained inuiively as follows. From he relocaion effec of (7), he consumpion in counry decreases, which requires a depreciaion of counry s currency o resore money marke equilibrium. Therefore, he moneary expansion in counry A reduces he real price of counry s goods relaive o counry C s goods because of he depreciaion of counry s currency (see equaion (6)), which causes world demand o swich from counry C s goods o counry s goods. This demand shif increases he relaive profis of firms locaed in counry, which causes firms locaed in counry C o relocae o counry (see equaion (8)). As a resul, he relocaion reduces he relaive labor income of counry C, which decreases he relaive consumpion of counry C (see equaion (3)). In sum, when relocaion is included in he model, a permanen moneary shock in counry A always benefis counry A in erms of relaive consumpion level, while i can be derimenal no only o counry, bu also o counry C. 8

20 9 5.. The case of, = = = = > = C C A A In his subsecion, we focus on he impacs of a permanen moneary shock in counry : > =. In his case, he closed-form soluions for he six key variables are as follows: ( )( ) ( ) ( ) < + + = A E E, (36) ( )( ) ( ) ( ) > + = E, (37) ( )( ) ( ) ( ) 3 < + + γθ = n, (38) ( ) ( )( ) ( ) ( ) 3 > + θ γ = m, (39) ( ) ( )( ) ( ) ( ) < = = A A E E C C, (4) ( )( ) ( ) ( ). > + = = C E C C (4) The above resuls can be explained inuiively as follows. Firs, an unanicipaed moneary expansion in counry requires an insananeous depreciaion of is currency o resore money marke equilibrium for a given level of iniial relaive consumpions. Under a given E A, his hen leads o a reducion in he real price of counry s goods

21 relaive o boh counry A s and counry C s goods because of he depreciaion of counry s currency (see equaions (36) and (37)), which causes world demand o swich from boh counry A s and counry C s goods o counry s goods (he expendiure-swiching effec). These demand shifs increase he relaive profis of firms locaed in counry, which causes firms locaed in counries A and C o relocae o counry (he relocaion effec; see equaions (38) and (39)). As a resul, he relocaion increases he labor income of couny and decreases he labor incomes of counries A and C, which raises he relaive consumpions of counry (see equaion (4) and (4)). In sum, when relocaion is included in he model, a permanen moneary shock in counry always benefis counry in erms of relaive consumpion level, while i can be derimenal boh o counry A and o counry C The case of C C, A A = > = = = = In his subsecion, we focus on he impacs of a permanen moneary shock in counry C: C C = >. In his case, he closed-form soluions for he six key variables are as follows: A C E E = <, (4) ( ) ( ) C E = <, (43) ( ) ( ) 3 C n = γθ <, (44) ( ) ( )

22 ( 3 ) C m = γ θ <, (45) ( ) ( ) C C C C C = E = <, (46) ( ) ( ) C A C C = ( ( )( ) ) A C + E E E = ( ) ( ) C <. (47) The above resuls can be explained inuiively as follows. Firs, an unanicipaed moneary expansion in counry C requires an insananeous depreciaion of counry C s currency o resore money marke equilibrium for a given level of iniial relaive consumpions ( E A = E <, see equaion (43)). Therefore, in his sage, counry A s currency relaive o s remains unchanged because E A E =. Therefore, he moneary expansion in counry C reduces he real price of counry C s goods relaive o counry s goods because of he depreciaion of counry C s currency, which causes world demand o swich from counry s goods o counry C s goods (he expendiure-swiching effec). This demand shif increases he relaive profis of firms locaed in counry C, which causes firms locaed in counry o relocae o counry C (he relocaion effec; see equaion (45)). The relocaion hen raises he labor income of counry C and decreases he labor income of counry, which raises he relaive consumpion of counry C (see equaions (46)). ecause of hese effecs, counry s currency mus depreciae o resore equilibrium in he marke for real balances. This depreciaion of counry s currency weakens he iniial appreciaion of is currency, and consequenly he relaive change in counry A s currency is negaive ( E A E <, see equaion (4)). Furhermore, his hen leads o a reducion in he real price of

23 counry s goods relaive o counry A s goods, which causes world demand o swich from counry A s goods o counry s goods. These demand shifs increase he relaive profis of firms locaed in counry, which causes firms locaed in counry A o relocae o counry (see equaion (44)). The relocaion hen decreases he labor income of counry A, which decreases he relaive consumpion of counry A (see equaions (47)). In sum, when relocaion is included in he model, a permanen moneary shock in counry C always benefis counry C in erms of relaive consumpion level, while i can be derimenal no only o counry, bu also o counry A. 6. Conclusion In his paper, we have generalized he Corsei e al. () model, which allows for inernaional relocaion of firms among hree counries. We have used his generalized model o consider he quesion of how allowing for inernaional relocaion of firms affecs he responses of boh consumpion and exchange raes o moneary shocks. From his analysis, we succeeded in showing explicily he effecs of moneary policy shocks, which lead o firm relocaion among hree counries, and i was found ha when relocaion maers, a permanen moneary shock in one of he hree counries always benefis ha counry, while i can be derimenal o he oher wo counries, in erms of relaive consumpion level. References Aizenman, J., 994. oneary and real shocks, producive capaciy and exchange rae regimes. Economica 6,

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29 Tille, C., 8. Financial inegraion and he wealh effec of exchange rae flucuaions. Journal of Inernaional Economics 75, Warnock, F.E., 3. Exchange rae dynamics and he welfare effecs of moneary policy in a wo-counry model wih home-produc bias. Journal of Inernaional oney and Finance,