Beggar-thyself or beggar-thy-neighbour? The welfare e ects of monetary policy

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1 Beggar-hyself or beggar-hy-neighbour? The welfare e ecs of moneary policy Juha Tervala and Philipp Engler February 28, 2 Absrac The paper analyses wheher moneary expansion is a beggar-hyself or beggar-hy-neighbour policy. Obsfeld and Rogo (995) show ha moneary expansion under producer currency pricing increases domesic and foreign overall welfare, in case where he cross-counry subsiuabiliy is high. If he cross-counry subsiuabiliy is low, hen moneary expansion is a beggar-hyself policy ha reduces domesic welfare and increases foreign welfare (Corsei and Peseni 2, Tille 2). In his paper i is shown ha regardless of wheher he crosscounry subsiuabiliy is high or low, moneary expansion is always a beggar-hyself policy in he shor run. Keywords: Open economy macroeconomics, moneary policy, beggarhyself, beggar-hy-neighbour JEL classi caion: E32, E52, F3, F4 Juha Tervala: Aboa Cener for Economics and Universiy of Turku, Assiseninkau 7, 24 Turun yliopiso, Finland, el: , juha.ervala@uu. ; Philipp Engler: Freie Universiä Berlin, Bolzmannsr. 2, 495 Berlin, Germany, el: , philipp.engler@fu-berlin.de.

2 Inroducion The US Federal Reserve and he European Cenral Bank have implemened expansionary moneary policies during he recen global recession in an aemp o simulae heir economies. An imporan quesion abou expansionary moneary policies is wheher such a policy sance is beggar-hy-neighbour or beggar-hyself, i.e. wheher i is bene cial or derimenal for he domesic economy and wha he e ecs are for he res of he world. Wih exible exchange raes and open capial markes, a permanen increase in he supply of money depreciaes he currency and increases expors and employmen. From he perspecive of he radiional Mundell-Fleming model his policy would be recommended o he domesic policy maker if increasing oupu is he policy goal. Since he publicaion of he Redux model by Obsfeld and Rogo (995), he quesion wheher a permanen moneary expansion is welfare improving or no has been analysed in he framework of fully micro-founded wocounry models. The welfare measure employed is he discouned presen value (DPV) of he change in uiliy of he domesic and foreign represenaive households. They show ha a moneary shock increases he DPV of uiliy by he same amoun in boh counries, in case where he elasiciy of subsiuion beween goods produced in di eren counries (he cross-counry subsiuabiliy) is he same as he elasiciy of subsiuion beween goods produced in he same counry (he wihin-counry subsiuabiliy). On he oher hand, Corsei and Peseni (2) and Tille (2) nd ha he gains in domesic oupu are more han o se by deerioraing erms of rade, if he cross-counry subsiuabiliy is lower han he cross-counry subsiuabiliy. 2 Wha has been missing unil recenly in his lieraure, however, was a Lane (2) provides an early and exensive survey of he New Open Economy Macroeconomics lieraure. Lane and Ganelli (23) focus on he exchange rae pass-hrough debae and he role of he curren accoun in adjusmen dynamics. Corsei (27) provides a more recen survey. 2 Furher conribuions o his lieraure challenging he basic resuls of Obsfeld and Rogo (995) on he posiive cross-counry spillover e ecs of moneary policy shocks include Bes and Devereux (2), Warnock (23) and Tille (28). Bes and Devereux (2) show ha under local currency pricing a counry may improve is erms of rade and hus raise is consumpion and welfare, a he expense of is neighbour. Warnock (23) shows ha a beggar-hy-neighbour e ec can resul in he presence of a home bias in consumpion. More recenly Tille (28) shed ligh on he role of cross-counry holdings of di eren asse classes showing, iner alia, ha cross-counry equiy holdings can reduce he ne dividend paymens o he res of he world when he money shock increases real wages and reduces pro s resuling in a posiive welfare di erenial. 2

3 horough analysis of he evoluion of welfare over ime. 3 The conribuion of his paper is o go beyond he above-menioned sudies, which employ simulaneous one-sep-ahead pricing, and o analyse he welfare e ecs of moneary policy over ime. To do his, we exend hese models wih he Calvo-pricing mechanism. The main resul of his paper is ha he frameworks of Obsfeld and Rogo (995), Corsei and Peseni (2) and Tille (2) in he end generae a common resul: A moneary shock is a beggar-hyself policy in he shor run, no maer wheher he cross-counry subsiuabiliy equals o or is smaller han he wihin-counry subsiuabiliy. The inuiion behind his resul is he following: in all cases a moneary shock causes an increase in domesic oupu wihou an equivalen increase in consumpion. In addiion, we show ha a high value of he cross-counry subsiuabiliy implies a higher decrease in domesic welfare in he shor run. Tha is, he beggarhyself e ec is he sronges in he Obsfeld-Rogo case. The main reason being ha a high cross-counry subsiuabiliy implies a srong expendiure swiching e ec. This causes a high response of oupu (employmen) wihou an equivalen increase in consumpion due o a deerioraion in he erms of rade and he accumulaion of ne exernal asses. The res of he paper is organised as follows. In secion 2 we presen he model. In secion 3 we analyse he welfare e ecs of an unexpeced shock o he domesic money supply, using illusraive numerical simulaions. Secion 4 concludes he paper. 2 The Model In his secion, we develop a sandard New Open Economy Model in he radiion of he Redux model (Obsfeld and Rogo, 995). 4 The world economy consiss of wo counries, home and foreign. There is a coninuum of rms and households ha are indexed by z 2 [; ]. A fracion n of hese are locaed in he home counry while he remaining fracion n are locaed in he foreign counry. Nominal price rigidiy is inroduced by he mechanism proposed by Calvo (983). This mechanism allows for an analysis of he welfare e ecs of moneary policy over ime which goes beyond he sudies of Obsfeld and Rogo (995), Corsei and Peseni (2) and Tille (2) 3 In a relaed paper, Tervala (2) analyses he quesion of how he welfare e ecs of moneary policy over ime depend on he currency of expor pricing, using a version of he Bes-Devereux (2) model. 4 I is based on Bes and Devereux (2), Pierdzioch (26), Tille (2) and Tervala (2). 3

4 which employ simulaneous one-sep-ahead pricing. 2. Households 2.. Preferences All households have idenical preferences. The uiliy funcion of he represenaive domesic household is given by 5 " X U (z) = s log C s + # " 2 Ms `s (z) ; () " 2 s= where is he discoun facor, C is a consumpion index (de ned below), " and are posiive parameers, M is nominal money balances, P is he consumer price index (de ned below) and ` denoes he supply of labour. The overall consumpion index is C = P s hn (C h ) + ( n) (C f ) i ; where C h (C f ) is an index of domesic (foreign) goods and > measures he elasiciy of subsiuion beween domesic and foreign goods. As in Tille (2), his elasiciy is referred o as he cross-counry subsiuabiliy. The consumpion indexes are de ned as C h = 2 4n Z n o 3 (C h (z)) dz 5 2 ; C f = 4( n) Z n 3 (C f (z)) dz 5 where c h (z) (c f (z)) denoes consumpion of domesic (foreign) good z and > is he elasiciy of subsiuion beween goods produced in he same counry. Following Tille (2), his is referred o as he wihin-counry subsiuabiliy. The opimal allocaion of consumpion beween di eren ypes of goods is governed by he following equaions p C h h (z) = (z) P h " # " # C P h ; C f p f (z) P f (z) = C P P f ; P C h (z) = p h (z) P h " # P h y C P ; C f (z) = " p f P f (z) # " # P f C P : 5 For he foreign counry equivalen equaions apply unless hey are explicily discussed. ; 4

5 The prices and price indexes are denoed as follows: p h (z) (p f (z)) is he domesic currency price of a domesic (foreign) good z, P h (P f ) is he price index of domesic (foreign) goods and P is he domesic consumer price index. All of hese price indexes are expressed in domesic currency erms. Analogously, for insance, p h (z) (p f (z)) is he foreign currency price of domesic (foreign) good. The law of one price holds in each good so ha p h (z) = S p h (z), where S is he nominal exchange rae (he domesic currency price of foreign currency). Thus, he purchasing power pariy holds: P = S P : The domesic price indexes are given by Z n P h = n p h (z) P = Z dz ; P f = ( n) p f (z) n h i n(p h ) + ( n)(p f ) : dz 2..2 Budge consrains and opimal behaviour The budge consrain of he represenaive domesic household is M + D = D + M + w ` P C + + P : (2) Here is he price of he bond ( = ( + i ), where i is he nominal ineres rae) ha pays one uni of domesic currency in period +, D denoes bonds held a he beginning of period, w is he nominal wage paid o he household in a compeiive labour marke, denoes he nominal pro s (dividends) of domesic rms and is ransfers from he governmen (seigniorage revenues). All domesic households own an equal share of all domesic rms. The capial marke is inegraed and he only inernaionally raded asse is a domesic currency denominaed bond. 6 Consequenly he budge consrain of a represenaive foreign household is M + D S = D S + M + w ` P C + + P : (3) The opimal behaviour of households is governed by he following equaions: P + C + = P C ; (4) P +C +S + = P C S ; (5) 6 The aggregae asse-marke-clearing condiion is hus given by nd + ( n) D =. 5

6 M P ` = ` = w C P ; (6) w C P ; (7) M C " = ; (8) P = C S + S! " : (9) Equaions (4) and (5) govern he opimal consumpion over ime. Equaions (6) and (7) govern he opimal labour supply. Equaions (8) and (9) show he money demand funcions. 2.2 Moneary policy We absrac from governmen spending so ha he ransfers o households are given by = M M P : () The money supply is assumed o follow a rs-order auoregressive process described by he following equaion ^M = ' ^M + M; ; where percenage changes from he iniial seady sae (denoed by he subscrip zero) are denoed by has ( ^M = dm =M ), and M; is an unpredicable shock o he money supply ( M; N(; 2 ). 2.3 Supply side: Firms 2.3. Pro s and demand All rms produce a di ereniaed good. represenaive domesic rm is The producion funcion of he y (z) = ` (z) ; () where y (z) is he oal oupu of i and ` (z) is he labour inpu used by i. The rm maximises pro s (z) = p (z) y (z) w ` (z) ; (2) 6

7 aking ino accoun he above producion funcion and he demand curve i faces p y d h (z) = (z) P h C W ; P P h P h where C W is he world demand (C W = nc + ( n)c ). Thus he pro s can be wrien as p h (z) = (z) P h C W p h (z) w : P Price seing In he absence of nominal rigidiies, he domesic rm maximizes pro s wih respec o p h (z) yielding he opimaliy condiion p h (z) = w : (3) So ha he price of he good is jus a markup, deermined by he wihincounry subsiuabiliy, over he marginal cos. To be able o analyse he behaviour of welfare over ime we assume he price seing srucure of Calvo (983). Each rm reses is prices wih a probabiliy in each period, independenly of oher rms and he ime elapsed since he las adjusmen. When seing is pro -maximizing price, he rm has o ake ino accoun ha in every subsequen period here is a probabiliy < < ha i will no be able o revise is price-seing decision. So he rm maximises he discouned value of expeced real pro s max p h (z) V (z) = E X s= s Q ;s s (z) P s ; where E denoes expecaions, and Q ;s is a sochasic discoun facor beween period and period s. The rs-order condiion can be wrien as P E p h s= s Q C W s P h s ;s Ps Ps (z) = h ws P s P E s= s Q C W : (4) s P h s ;s Ps P s The log-linear version of equaion (4) can be wrien as P h s ^p h (z) = E ^p h +(z) + ( ) ^w : This equaion simply saes ha he opimal price is he weighed average of he curren and fuure nominal marginal coss. 7

8 2.4 Symmeric equilibrium All rms in a counry are symmeric so ha every rm ha changes is price in any given period chooses he same oupu and ses he same price. The srucure of price seing implies ha in each period a fracion of rms ( ) se a new price, while he remaining fracion keep heir price unchanged. The consolidaed budge consrain of he home economy is derived by using equaions (2), () and (2) 7 P C ; = p h (z) y (z) + D D : (5) The model is log-linearized around a symmeric seady sae where all exogenous variables are consans and where iniial ne foreign asses are zero. Equaions (6), () and (3) imply ha in he iniial level of employmen is 2 y = ` = : 2.5 Choice of parameer values The choice of parameer values (if possible) follows Tille (2), making i easier o compare he resuls of his model wih hose of his model. The wihin-counry subsiuabiliy () is se o 6. The consumpion elasiciy of money demand (=") is se o. The relaive size of he home counry (n) is se o.5. The domesic money shock is permanen (' = ) and is size is uniy ( M; = ). In he model of Tille (2) all prices are prese for one period, which he inerpres as one year, and fully exible afer ha. In a model wih he Calvo-price seing framework i is more naural o inerpre periods as quarers. Thus, he discoun facor is se o :99. In addiion, he price sickiness parameer () is se o.5, implying an average delay beween price adjusmens of wo periods. This is consisen wih he ndings of Bils and Klenow (24). The crucial parameer is he cross-counry subsiuabiliy (). In he basic seing, we use a value of 6 so ha i is equal o he wihin-counry subsiuabiliy. In his case, he model replicaes he resuls of Obsfeld and Rogo (995). This a naural benchmark o analyse he implicaion of lowering he cross-counry subsiuabiliy o 3, and The corresponding foreign equaion is P C = p f (z) y n (z) n S + n n 8 We solve he model using he algorihm developed by Klein (2) and McCallum (2). D D S : 8

9 3 Welfare e ecs of moneary policy 3. Mehod of welfare analysis In many New Open Economy Models (including Corsei and Peseni (2), Obsfeld and Rogo (996) and Tille (2)) all prices are xed for one period and he economy reaches he new seady sae afer ha period. Then, he welfare e ec is he shor-run change in uiliy plus he discouned presen value of he change in seady-sae uiliy. Due o saggered price seing, a di eren mehod is needed evaluae he welfare e ecs of moneary policy. We follow he same mehod as in Ganelli and Tervala (2) and Tervala (2), we rs sudy he change in periodby-period uiliy. Then we calculae he discouned presen (DPV) value of hese changes. The change in uiliy in period is given by ^U = ^C `2^`: The DPV of hese changes is ^U DP V = X s ^Us : s= Figures and 2 illusrae he changes in he period s uiliy and able shows hese changes in he rs period and in he seady sae (SS). I also shows he DPV of he change in uiliy. Table : Welfare e ecs of moneary shocks ^U ^U ^Uss ^U ss ^UDP V ^U DP V = : = = = = Basic case Figure (on page 8) shows he impulse response funcions in he basic case, where he cross-counry subsiuabiliy is equal o he wihin-counry subsiuabiliy ( = = 6). In his case, he model more or less replicaes he resuls of Obsfeld and Rogo (995) and hose of Tervala (2). We regard his as a naural benchmark for he analysis in he nex secion. In all gures, he verical axes show percenage deviaions from he iniial seady sae, excep for he change in bond holdings which are expressed as a 9

10 deviaion from iniial consumpion. The domesic erms of rade are de ned as he relaive price of domesic expors in erms of is impors. Consequenly, is erms of rade improve if his index rises. The change in he erms of rade is given by dt ot = ^b (z) b S ^b (z) (6) where ^b (z) and ^b (z) are, respecively, he Calvo-weighed prices of domesic and foreign goods ^b (z) = ^b (z) + ( ) ^p h (z) ; ^b (z) = ^b (z ) + ( ) ^p f (z) : The Obsfeld-Rogo case is well-known in he lieraure, herefore we focus on he behaviour of welfare over ime. Saggered price seing does no change he equaion governing he behaviour of he exchange rae. Thus i is deermined by he same equaion as in he Obsfeld-Rogo model (995, 64): ^S = ( ^M ^M ) " ( ^C C b ): (7) Thus he domesic money shock depreciaes he exchange rae. This lowers he relaive price of domesic goods, shifing global demand oward domesic goods away from foreign goods, as long as prices are sicky. This expendiureswiching e ec induces an increase in domesic oupu and a decrease in foreign oupu. The shock lowers he real ineres rae and global consumpion increases. The households in boh counries face he same real ineres rae implying ha he shock changes heir consumpion pro les proporionaely. However, he expendiure-swiching e ec causes a shor run increase in relaive domesic consumpion. The domesic households save par of his exra income by running a curren accoun surplus. Wih higher long-run wealh, hey decrease heir labour supply. This decreases long-run oupu. A fall in he supply of domesic goods causes an improvemen in he heir erms of rade. Obsfeld and Rogo (995) show ha a moneary shock increases overall uiliy (DPV of uiliy) by he same amoun in he boh counries, despie asymmeric oupu e ecs. The presen model is consisen wih his nding, as able shows. The liquidiy e ec of moneary policy increases world oupu, bringing i closer o is e cien level and consequenly increasing overall welfare in boh counries. Moreover, he behaviour of he erms of rade provides he channel for sharing he bene s of moneary policy equally. The curren accoun channel does a ec overall welfare due o ineremporally opimizing households.

11 In any case, he erms of rade and curren accoun e ecs have implicaions for he behaviour of welfare over ime, as is shown in a relaed paper (Tervala 2). The accumulaion of exernal asses and he deerioraion in he domesic erms of rade implies ha domesic consumpion increases less han proporionally o oupu (employmen). Moneary expansion herefore is a beggar-hyself policy in he shor run. Panel (f) in gure and able shows ha domesic uiliy increases in he long run. Higher domesic wealh allows consumpion o be higher han oupu (recall equaion (5)). This curren accoun e ec and he improvemen in he erms of rade have a favourable e ec on consumpion and consequenly on welfare. Panel (f) shows he domesic shock increases foreign welfare in he shor run. This is because of an increase in consumpion and a fall in employmen (oupu). In he long run, foreign households work more, due o lower longrun wealh, and oupu increases. This parly causes a deerioraion of he foreign erms of rade. In addiion, he foreign counry mus run a rade balance surplus o service he exernal deb. These curren accoun and erms or rade e ecs have a negaive e ec on consumpion and consequenly on welfare in he long run. 3.3 Low cross-counry subsiuabiliy In his secion we analyse wha happens o he evoluion of welfare over ime when he value of he cross-counry subsiuabiliy is reduced. In his exercise i is below he benchmark value of 6 and he wihin-counry subsiuabiliy. As emphasised by Tille (2, 422), his is likely o be he mos relevan from he empirical poin of view: if counries specialise in he producion of cerain ypes of goods, he cross-counry subsiuabiliy is likely o be smaller han he wihin-counry subsiuabiliy. As he opposie case is less ineresing, we only repor he welfare resuls for = 9 in Table. Figure 2 and Table show he e ecs of varying he cross-counry subsiuabiliy. The resuls regarding he DPV of he change in uiliy are consisen wih Tille (2): a moneary expansion is a beggar-hyself policy only if here is less subsiuabiliy across counries han wihin. A moneary shock increases domesic oupu bu does no allow households o purchase enough addiional consumpion o o se he cos of heir e or due o he deerioraion in he erms of rade. The higher deerioraion in he domesic erms of rade implies ha he counries do no share he bene s of moneary policy equally, unlike in he Obsfeld-Rogo case. The presen model, however, o ers imporan insighs ino he welfare ef-

12 fecs of moneary policy once we focus on welfare dynamics. Firsly, Table and Figure 2 show ha reducing he value of he cross-counry subsiuabiliy implies a smaller decrease in domesic welfare in he shor run. Moreover, his happens despie a higher shor-run deerioraion in he domesic erms of rade. Secondly, regardless of wheher he cross-counry subsiuabiliy is equal o he wihin-counry subsiuabiliy or lower, a moneary expansion is - in he shor run - always a beggar-hyself policy, reducing domesic welfare and increasing foreign welfare. Le us focus rs on he case of = 3: When domesic and foreign goods are poorer subsiues, he depreciaion of he nominal exchange rae induces a weaker expendiure swiching e ec owards domesic goods and away from foreign goods. Boh he increase of domesic relaive o foreign oupu and he absolue increase in domesic oupu fall, when compared wih he basic (Obsfeld-Rogo ) case. The laer implies ha a money shock reduces domesic welfare by less han in he basic case. As shown by Tille (2), he cross-counry subsiuabiliy is equal o he sum of he expor and impor elasiciies, wih respec o he erms of rade. And ha if i is greaer han one, hen he Marshall-Lerner-Robinson condiion holds and an exchange rae depreciaion generaes a curren accoun surplus. In his model, he smaller he cross-counry subsiuabiliy, he smaller he increase in relaive domesic income. Panel (e) of Figure 2 shows ha households have less incenive o lend inernaionally, when compared wih he basic case. Thus, he e ec of he curren accoun channel on domesic welfare becomes weaker. This is parly he reason why domesic welfare is smaller han he basic case in he rs period afer he shock. The smaller value of implies ha for any given change of demand, a bigger change in he erms of rade is needed o resore he equilibrium, as poined ou by Tille (2). In his model, all goods prices are xed in he shor run and only he nominal exchange rae can change he erms of rade in he shor run. In our model wo e ecs change he erms of rade. The smaller consumpion di erenial across counries increases he depreciaion of he nominal exchange rae (see equaion (7)), as in Tille (2). As his e ec is raher small, he second e ec is more imporan here. In our model he relaive price of domesic o foreign goods can also change among hose rms ha are able o change heir prices in he rs period (see equaion (6)). When domesic and foreign goods are poorer subsiues, a given swich in demand requires a higher change in he opimal relaive price of domesic and foreign good, here his implies ha ^b (z) ^b (z) increases less. Even hough he adjusmen mechanisms are di eren in our and Tille s model, in boh models he deerioraion in he erms of rade is higher han in he basic case. 2

13 A higher deerioraion in he erms of rade implies smaller domesic consumpion. This causes a higher reducion in domesic welfare in he shor run. Bu i is, however, more han o se by he smaller curren accoun e ec and he smaller increase in oupu so ha he decrease in domesic welfare is smaller han in he basic case in he shor run. The welfare e ecs in he long run are smoohed as he increase in accumulaed wealh is smaller. Table also shows ha he DPV of he change in uiliy is, consisen wih Tille (2), negaive for = 3. The long-run posiive e ec of welfare is no large enough any more o compensae for he negaive shor run e ec. The e ec on foreign welfare is driven by he opposie e ecs following he erms of rade adjusmen: The smaller expendiure swiching e ec implies a smaller decrease in foreign oupu and hereby reducing he shor run posiive welfare e ec. A he same ime, he lower reducion of bond holdings decreases he long-run negaive welfare e ec as less e or is needed o pay ineres on he foreign deb. Corsei and Peseni (2) and Tille (2) have shown ha in case of = a money shock does no generae curren accoun imbalances and a deerioraion in he domesic erms of rade reduces he DPV of he change in uiliy. In his case, he increase in demand for domesic goods does no increase he relaive domesic income (and consumpion) and consequenly here is no incenive o lend inernaionally. The assumpion herefore eliminaes he curren accoun channel. The resuls shown in Figure 2 and Table are consisen wih he resuls of he above-menioned sudies. The presen model, however, illusraes an imporan new poin. Bear in mind ha one of he main resuls of Corsei and Peseni (2) and Tille (2) was ha if he cross-counry elasiciy is uniy, hen an exchange rae depreciaion is a beggar-hyself policy, conrary o he welfare resul of Obsfeld and Rogo (995). Panel (g) and Table show ha if he crosscounry elasiciy is uniy, hen a fall in domesic welfare is much smaller han in he basic Obsfeld-Rogo case in he shor run. A weaker expendiure swiching e ec owards domesic goods implies ha he increase in domesic oupu is smaller. Consequenly shor run domesic welfare falls by less han in he basic case. Even when reducing o small values of below, he domesic welfare e ec of moneary policy remains negaive in he shor run. The nding ha moneary policy is beggar-hyself in he shor run is hus a robus resul. In he case of = :5, domesic and foreign goods are poor subsiues and a deerioraion in he domesic erms of rade reduces he domesic sales revenue. This is because he Marshall-Lerner-Robinson condiion does no hold. Thus a moneary expansion generaes a fall in relaive domesic income 3

14 and consumpion. The domesic household accumulaes deb in he shor run by running a curren accoun de ci. This end o increase shor run welfare. The erms of rade e ec, however, dominaes he curren accoun channel o an exen ha he increase in consumpion is smaller han he increase in oupu in he shor run. In his case, domesic households, wih lower long-run wealh, increase heir labour supply. This increases long-run oupu. An increase in he supply of domesic goods causes an permanen deerioraion in he heir erms of rade. Table hus shows a fall in domesic uiliy in he long run. Lower domesic wealh implies ha oupu mus be higher han consumpion. This curren accoun e ec and he deerioraion in he erms of rade have a negaive e ec on consumpion and consequenly on welfare. The conribuion of his paper is o analyse he welfare e ecs of moneary policy over ime, going beyond he sudies of Obsfeld and Rogo (995), Corsei and Peseni (2) and Tille (2) which employ simulaneous one-sep-ahead pricing. Obsfeld and Rogo (995) show ha a moneary shock increases he DPV of uiliy by he same amoun in he boh counries. On he oher hand, Corsei and Peseni (2) and Tille (2) nd ha he gains in domesic oupu are more han o se by deerioraing erms of rade, if he cross-counry subsiuabiliy is low. In his paper i is shown hese frameworks in he end generae a common resul: A moneary shock is a beggar-hyself policy in he shor run, no maer wheher he cross-counry subsiuabiliy equals or is smaller han he wihin-counry subsiuabiliy. 4 Conclusions In his paper, we focused, in he conex of a sandard open-economy model wih imperfec compeiion and nominal rigidiies, on he quesion wheher an expansionary moneary policy is beggar-hy-neighbour or beggar-hyself. Prior research shed ligh only on he discouned presen value of welfare, an approach which misses he poenially imporan ime dimension. I has shown ha he cross-counry subsiuabiliy is a key parameer governing he inernaional welfare e ecs of moneary policy. Using a more advanced mehod for welfare analysis, we show ha in he shor-run such a policy is beggar-hyself and ha his resul does no depend on he size of he crosscounry subsiuabiliy. In he res of he world welfare increases in he shor-run while long-run e ecs depend on he cross-counry subsiuabiliy boh a home and abroad. Super cially one could conclude ha he recen expansionary moneary policies of he US Federal Reserve and he European Cenral Bank can be 4

15 expeced o increase welfare only afer a while. However, his policy sance was a reacion o a severe recession while our resuls are based on he assumpion of full employmen. Thus, a crucial assumpion for he welfare crierion employed is ha monopolisic compeiion and price rigidiies are he only disorions. Exending he model o allow for involunary unemploymen due o labour marke ine ciencies would be an ineresing exension and is lef for fuure research. 5

16 References [] Bes, C. Devereux, M. (2): Exchange Rae Dynamics in a Model of Pricing-o-Marke. Journal of Inernaional Economics 5, [2] Calvo, G. (983): Saggered Prices in a Uiliy Maximizing Framework. Journal of Moneary Economics 2, [3] Corsei G., (27): New Open Economy Macroeconomics. European Universiy Insiue Working Papers, Rober Schuman Cener for Advanced Sudies 27/27. [4] Corsei, G. Peseni, P. (2): Welfare and Macroeconomic Inerdependence. Quarerly Journal of Economics 6, [5] Ganelli, G. Tervala, J. (2): Public Infrasrucures, Public Consumpion, and Welfare in a New-Open-Economy-Macro Model. Journal of Macroenomics, forhcoming. [6] Klein, P. (2): Using he Generalized Schur Form o Solve a Mulivariae Linear Raional Expecaions Model. Journal of Economic Dynamics & Conrol 24, [7] Lane, P. (2): The New Open Economy Macroeconomics: A Survey. Journal of Inernaional Economics 54, [8] Lane, P. Ganelli, G. (23): Dynamic General Equilibrium Analysis: The Open Economy Dimension. In Alug, S. Chanda, J. Nolan, C. (eds.) Dynamic Macroeconomic Analysis. Cambridge Universiy Press, Cambridge. [9] McCallum, B. (2): Sofware for RE Analysis. Compuer sofware available a hp://wpweb2.epper.cmu.edu/faculy/mccallum/research.hml [] Obsfeld, M. Rogo, K. (995): Exchange Rae Dynamics Redux. Journal of Poliical Economy 3,

17 [] Obsfeld, M. Rogo, K. (996): Foundaions of Inernaional Macroeconomics. MIT Press, Cambridge. [2] Pierdzioch, C. (26): Capial Mobiliy, Consumpion Subsiuabiliy and he E ecs of Moneary Policy in Open Economics. German Economic Review 6, [3] Tille, C. (2): The Role of Consumpion Subsiuabiliy in he Inernaional Transmission of Moneary Shocks. Journal of Inernaional Economics 53, [4] Tille, C. (28): Financial Inegraion and he Wealh E ec of Exchange Rae Flucuaions. Journal of Inernaional Economics 75, [5] Tervala, J. (2): The Inernaional Transmission of Moneary Policy in a Dollar Pricing Model. Open Economies Review, forhcoming. [6] Warnock, F. (23): Exchange Rae Dynamics and he Welfare E ecs of Moneary Policy in a Two-Counry Model wih Home-Produc Bias. Journal of Inernaional Money and Finance 22,

18 Figure : E ecs of a moneary shock in he basic case ( = = 6) (a) Oupu.2 (b) Consumpion.8.6 Domesic Foreign.5 Domesic Foreign (c) Exchange rae. (d) Domesic erms of rade (e) Bond holdings of domesic households.5 (f) Welfare.6 Domesic Foreign

19 Figure 2: Low cross-counry elasiciy (a) Domesic oupu.2 (b) Foreign oupu ρ=6 ρ=3 ρ= ρ=.5.2 ρ=6 ρ=3 ρ= ρ= (c) Domesic consumpion.2 (d) Foreign consumpion.5..5 ρ=6 ρ=3 ρ= ρ= ρ=6 ρ=3 ρ= ρ= (e) Bond holdings of domesic households. (f) Domesic erms of rade.4.2 ρ=6 ρ=3 ρ= ρ= ρ=6 ρ=3 ρ= ρ= (g) Domesic welfare.6 (h) Foreign welfare ρ=6 ρ=3 ρ= ρ= ρ=6 ρ=3 ρ= ρ=