Do Changes in Product Variety Matter for Business Cycles and Monetary Policy in Open Economies?

Authors

  • Stéphane Auray,

    Corresponding author
    • CREST (Ensai), Universités Lille Nord de France (ULCO) and EQUIPPE (EA 4018), France
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    • Stéphane Auray is also an associate member of GREDI and CIRPEE, Canada.

  • Aurélien Eyquem

    1. Université de Lyon, Ecole Normale Supérieure de Lyon, CNRS, GATE Lyon St Etienne,, France
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    • Aurélien Eyquem is also an associate member of GREDI, Canada.


  • We would like to thank the editors Fabio Ghironi as well as Benn Steil, and two anonymous referees for insightful comments. Aurélien Eyquem gratefully acknowledges the Fondation Banque de France for financial support.

Stéphane Auray

ENSAI - Campus de Ker-Lann

Rue Blaise Pascal - BP 37203

35172 BRUZ cedex

France

stephane.auray@ensai.fr

Abstract

Firms constantly seek to develop and commercialize new goods to satisfy consumer needs. This process of creation and destruction of product varieties has important implications for competition in goods markets and consumer welfare. According to Bernard et al. (2009), product creation typically accounts for a large share of national output. Since it also crucially affects the dynamics of inflation through its effect on competition, taking this process into account may challenge traditional views on monetary policy design and transmission. In this paper, we find that changes in the range of products available to consumers matter for our understanding of business cycles and the conduct of monetary policy in open economies. Our evaluation of the welfare implications of alternative monetary policy rules shows the importance of product varieties in the design of monetary policy. Much theoretical literature has found that price stability should be the key objective of monetary policy. Considering product creation in an open economy changes this policy recommendation, since welfare is higher when central banks respond moderately to output fluctuations in addition to responding to inflation.

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