Globalization, O↵shoring and Monetary Policy E↵ectiveness

This paper provides an empirical and theoretical investigation into the relationship between trade openness and the e↵ects of monetary policy changes. Using data from US industries at a 4-digit SIC level from 1972 to 2005, the empirical analysis reveals a negative relationship between trade openness and the e↵ects of identified monetary policy shocks on the output of manufacturing industries. Based on this evidence, the theoretical section develops an open economy New Keynesian model that features heterogeneous manufacturing firms and one-way o↵shoring from the advanced economy to the less developed one. A simultaneous decline in trade cost and o↵shoring cost weakens the e↵ect of monetary policy changes on output and inflation by dampening the responses of the domestic labor market: it raises labor demand elasticity and strengthens demand spillover. The calibrated model indicates that, when the economy moves from low trade regime and financial autarky to a modern trade regime with an incomplete international financial market, the monetary policy shocks have 22% less of an e↵ect on real GDP and consumer price inflation. The o↵shoring induced productivity e↵ect can moderately o↵set the dampening e↵ect of trade openness. JEL Classification: E52, F41, F62