Monetary and Economic Studies Vol.20, No.3 / October 2002

Pricing-to-Market (PTM) and the International Monetary Policy Transmission: The 'New Open-Economy Macroeconomics' Approach

Akira Otani

Empirical analyses of firms’ price-setting behavior show that while the exchange rate pass-through of Japanese firms is low (many Japanese firms adopt pricing-to-market [PTM]), the export prices charged by U.S. firms nearly perfectly reflect foreign exchange rate fluctuations. This paper analyzes how the difference in domestic and foreign firms’ price-setting behavior affects the domestic and international transmission of monetary policy by using a model that explicitly incorporates differences in the price-setting behavior of domestic and foreign firms. This model is constructed by adopting the framework of the “new open-economy macroeconomics” that has been the subject of numerous research papers in recent years. The findings demonstrate that the effects of domestic and foreign monetary policies differ greatly when domestic and foreign firms adopt different price-setting behaviors. This indicates that central banks have to give sufficient attention to firms’ price-setting behavior for the implementation of monetary policies. Additionally, model simulations based on Japan and U.S. data show that the external effect of Japanese monetary policy is negligible compared with that of U.S. monetary policy due to the PTM price-setting behavior of Japanese firms.

Keywords: New open-economy macroeconomics; PPP (purchasing power parity); PTM (pricing-to-market); Monetary policy; Beggar-thy-neighbor effect

Views expressed in the paper are those of the authors and do not necessarily reflect those of the Bank of Japan or Institute for Monetary and Economic Studies.

Copyright © 2002 Bank of Japan All Rights Reserved.

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