Does Monetary Policy Matter For Trade?

There is a large literature on the effect of exchange rate arrangements on trade. The monetary policy used in the floating exchange rate regime, however, is usually ignored and unidentified in the empirical studies. This makes the effect of alternative monetary policy regimes on trade remains largely unknown. This paper sheds light on this area by examining the effect of two well-defined monetary policy regimes, namely exchange-rate targeting and inflation targeting regimes, on bilateral and multilateral trade. Our result suggests a moderate positive effect of inflation targeting policy on bilateral trades between two inflation targeting countries. This effect of inflation targeting, even much moderate than the effect of currency union and a fixed exchange rate at the bilateral level, could exist in the bilateral trades with a large number of trading partners under the same regime. This implies that inflation targeting regime may not have a lower level of multilateral trade than exchange-rate targeting regime. We further support this view with an analysis of multilateral trade.