Effects of monetary policy on a rigid price model in different currencies
Keywords:
price setting currency, exchange rate, monetary policy, sticky pricesAbstract
In a two country dynamic model with sticky prices, this paper analyses the monetary policy transmission when firms set their prices in different currencies. Following Betts and Devereux (2000) we include an assumption that allows firms to set a unique price for local and foreign market in the currency of the importer. Some firms price to market and some firms set their prices in their own or their neighbor’s currency. The presence of sticky prices in the currency of the importer increases the volatility of exchange rate and reduces the positive effect that monetary policy has on consumption and real interest rates. In the absence of pricing to market, the bigger the number of firms that set their prices in the importer´s currency, the
bigger the effect that a monetary shock, in the foreign country, has on its welfare and on its neighbor´s. However, the positive effect is lower, in both countries, when the shock occurs in the local country.
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Ensayos de Política Económica