Title: Intermediate goods price shock, vertical trade and exchange rate regime
Authors: Kang Shi - Chinese University of Hong Kong (Hong Kong)
Zhouheng Wu - Guangdong University of Foreign Studies (China) [presenting]
Juanyi Xu - Hong Kong University of Science and Technology (Hong Kong)
Abstract: With the rapid growth of vertical trade in small open economies, the fluctuation of global intermediate goods price has become one of major uncertainties faced by these economies. A simple analytical two sector sticky price model is developed to show how global intermediate goods price shock affects small open economies through vertical trade. We find that welfare effects depend critically on the structure of vertical trade and exchange rate policy regime. Furthermore, we estimate an infinite period small open economy model using Bayesian Method and Canadian data. The results show that intermediate goods price shock can explain 42\% of the variance of output and 68\% of the variance of trade balance to output ratio, and welfare effects of intermediate goods price shock on the Canadian economy are even larger than those of technology shock. With the counterfactual experiment, we show that flexible exchange rate regime and high financial integration can mitigate the impacts of world intermediate goods price shock.