in domestic aggregate demand combined with these other effects offsets the drop in foreign demand and brings inflation sustainably back to target. the monetary policy transmission mechanism relies in the first instance on two key reduced - form parameters : the interest elasticity of aggregate demand and the exchange rate elasticity of aggregate demand. the issue to consider is how the evolution of international trade may have influenced these parameters over time, either directly, or through more subtle changes in the underlying structure of the economy. the ultimate effects on inflation will depend on the interaction between the domestic output gap and domestic inflation ( the phillips curve ). each of these relationships may be altered by an increase in cross - border integration. to illustrate, let ’ s compare a world in which entire products are produced in individual countries and exported to others, with one that is “ integrated ” or “ globalized, ” dominated by mnes with suppliers scattered around the world. in both states, global demand for a given product is the ultimate demand shock variable. however, the investment decisions of an mne will be driven more by global variables than individual domestic variables. this could include interest rate fluctuations — assuming the mne has access to global capital markets, its decision making may be less influenced by domestic interest rates and more by global interest rates. to date, however, there is very little empirical evidence for or against this conjecture, so we have set it aside. similarly, a fluctuation in an individual exchange rate may have a more muted impact on mnes in a globalized world, because for any given mne built on gvcs, the depreciation of one currency means an appreciation of another, both of which could be in the firm ’ s portfolio of demand and supply. in concrete terms, as a country becomes more integrated into gvcs, a depreciation of the exchange rate improves its competitiveness by only a fraction of the value of final goods exports, rather than the whole bundle ( ahmed, appendino and ruta 2015 ). furthermore, notice that the process of building a gvc involves increasing the degree of specialization at each point in the supply chain. this specialization presumably reduces the substitutability of producers across countries, thereby providing a second structural reason why the exchange rate elasticity of exports may decline with increased trade integration. in related literature, caselli et al. ( 2015 ) show that sectors that are more open to trade are less exposed to domestic supply and demand shocks and tend to be less correlated

activity from us and canadian firms. indeed, the maquiladoras today account for over 25 per cent of manufacturing employment in mexico ( bergin, feenstra and hanson 2009 ), while at the same time incorporating imported inputs from asia and elsewhere in latin america. chart 4 : domestic value added share of gross exports % % canada united states mexico euro area note : " 62 economies " equals 61 countries plus oecd's " rest of world " source : trade in value added ( tiva ), organisation for economic co - operation and development japan china average of 62 economies chart 5 : domestic value added share of gross exports in the manufacturing sector % % canada united states mexico euro area japan note : " 62 economies " equals 61 countries plus oecd's " rest of world " source : trade in value added ( tiva ), organisation for economic co - operation and development china average of 62 economies while these observations fit our hypothesis of increased integration across a large number of economies, two exceptions are worth noting. one is canada, where there has been a modest increase in domestic value added to total exports. the reason for this is that canada ’ s growth engine during much of the 2002 – 12 period was in the commodity sector — primarily oil — and this is of course largely domestic value added. data from canada ’ s manufacturing sector clearly show a declining portion of domestic value added, reflecting a globalization trend ( chart 5 ). the other interesting exception is china, which has been by far the most important recipient of gvc business, often in very labour - intensive forms. this means that the explosion of global trade in the wake of china ’ s accession to the wto has contained a large share of chinese domestic value added. over time, however, china has been creeping up the value - added chain, particularly in manufacturing, as chart 5 illustrates. yet another indicator of rising cross - border integration is the growing importance of foreign affiliates in facilitating trade. a domestic company has a choice of producing at home and shipping abroad, or locating abroad and shipping directly to that host country and to third countries. either arrangement may be supported by a global value chain. importantly, both cusfta and nafta liberalized and offered legal protection of crossborder investment, so to understand the effects of these agreements we need to look beyond the cross - border flows of goods and services. data on the operations of foreign affiliates with domestic majority ownership are less widely available and reported with a substantial la