nr 110 - Pricing-to-market, sectoral shocks and gains from monetary cooperation

DNB Working Papers
Publicatiedatum 22 augustus 2006

Recent literature states that international monetary cooperation results in substantial welfare gains in an environment with imperfectly correlated sectoral shocks and with prices only set in firms (domestic) currency. However, empirical studies provide evidence that firms not only set their prices in their own currency, but in foreign currency as well. The question is whether the result of substantial welfare gains due to imperfectly correlated sector-specific shocks applies to the case where firms in the tradable sector apply pricing-to-market, i.e. prices are set in both domestic and foreign currency. This paper finds that this is not the case. For imperfectly correlated sectoral shocks and local currency pricing, welfare benefits of international monetary cooperation are fairly small. Keywords: nominal rigidities, international cooperation, local currency pricing JEL classi.cation: E31, E52, F42