Optimal monetary policy in open economies: the role of reference currency in vertical production and trade

This paper examines optimal monetary policy rules in open economies with vertical production and trade in which we emphasize the role played by reference currency. As evidenced by empirical ï¬ndings, we assume ï¬nal goods prices are sticky, but intermediate goods prices are flexible. We ï¬nd that the asymmetry of exporters' pricing behavior implies that the responses of monetary authorities to productivity shocks from the stage of ï¬nal goods production are asymmetric but symmetric to productivity shocks from the stage of intermediate goods production. We also ï¬nd that gains from cooperation are related to the covariance of productivity shocks in two stages. In addition, we give the conditions under which home and foreign are willing to take part in cooperation respectively. As for exchange rate policy, we ï¬nd that the volatility of nominal exchange rate in RCP case is greater than that in LCP case, but smaller than that in PCP case. The volatility of real exchange rate in RCP case is, however, greater than those in PCP and LCP cases.