This paper studies how US dollar invoicing and the rise of global value chains (GVCs) affects the relationship between monetary policy, exchange rates and international trade.
We build a three-country dynamic stochastic general equilibrium (DSGE) model where two small open economies trade with each other as well as with a large global economy (representing the United States). All the economies export final goods to each other. In addition, the two small economies operate a GVC by exporting intermediate goods to one another that are processed further before shipping the final product to the US. We study how different segments of international trade (final goods vs GVCs) react to exchange rate movements triggered by monetary shocks. We test the predictions of the model using a granular decomposition of bilateral trade flows into the source, intermediate and final destinations of value added.
In response to both domestic and foreign shocks, the model has notably different implications for final goods trade, on the one hand, and GVC-oriented trade, on the other. For example, in response to a US monetary contraction and dollar appreciation, final goods trade between non-US countries declines by more than the GVC trade that services US final demand. The evidence in favour of the main predictions of the model is ambiguous when we consider only a coarse classification between final and intermediate goods trade that is available in standard databases. However, we find much stronger evidence for the model once we use input-output data to