Series: Working Papers. 2607.
Author: Pablo Aguilar, Rubén Domínguez-Díaz, José-Elías Gallegos and Javier Quintana
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Abstract
We analyze how production networks transmit foreign price shocks and reshape monetary policy trade-offs in an open-economy New Keynesian model with domestic and international input–output linkages. Analytically, we show that closing the output gap does not generally stabilize domestic inflation, as sector-level terms-of-trade movements and trade imbalances become additional drivers of inflation dynamics. Quantitatively, we study an international energy price shock in a model calibrated to major euro area countries and their trade partners. We find that production networks significantly amplify the cumulative headline inflation response and substantially worsen monetary policy trade-offs, as measured by the sacrifice ratio.