Beyond Competitive Devaluations: The Monetary Dimensions of Comparative Advantage

Motivated by the long-standing debate on competitive devaluation, we propose a new perspective on how monetary and exchange rate policies can contribute to a country’s international competitiveness. We refocus the analysis on the implications of monetary stabilization for a country’s comparative advantage. We develop a two-country New Keynesian model with two tradable sectors in each country: one perfectly competitive, the other producing differentiated goods under monopolistic competition subject to sunk entry costs and nominal rigidities and hence more sensitive to macroeconomic uncertainty. Monetary policy can disproportionately foster competitiveness of differentiated goods firms, ultimately affecting the composition of domestic output and exports.