Home-Product Bias, Capital Mobility, and the Effects of Monetary Policy Shocks in Open Economies

This paper uses a dynamic general equilibrium two-country optimizing model to analyze the consequences of international capital mobility for the effects of monetary policy in open economies. The model shows that the difference between the short-run output effects of monetary policy shocks in a world of high capital mobility and those in a world of low capital mobility decreases if households have a home-product bias in preferences. This result implies that, in contrast to conventional wisdom derived from the textbook Mundell-Fleming model, the empirically observed integration of international financial markets need not result in a significant change in the propagation of monetary policy shocks if households have a strong bias for consuming home products.