SPECIALIZATION, THE TERMS OF TRADE, AND THE INTERNATIONAL TRANSMISSION OF MONETARY POLICIES

The Ricardian model with a continuum of goods is extended to a cash-in-advance environment with variable labour supply, which allows domestic monetary policy to influence real activity through an inflation tax channel and to be internationally transmitted to real activity abroad. The continuum-of-goods feature of the model allows for the international transmission of monetary policies to occur at both intensive and extensive margins. At the intensive margin monetary policy is internationally transmitted via its impact on relative employment levels at home and abroad. This in tum alters the terms of trade, thereby affecting the range of commodities in which the home country has a comparative advantage. Monetary policies are thus transmitted at the extensive margin by influencing international patterns of trade and specialization.