Capital Mobility and the Output-Inflation Tradeoff

Prakash Loungani, Assaf Razin and Chi-Wa Yuen

No 1577, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: A common feature for developing countries that have experienced a sharp drop in inflation without large output losses is the extensive use of capital controls. This study shows that capital controls significantly improve the sacrifice ratio. This element contributes to the explanation of small output losses during disinflations, in addition to the high inflation mean and large nominal output variability in the pre-stabilization phase. A useful concept for disinflation episodes is the sacrifice ratio; the percentage decline in the rate of unemployment with 1% fall in the rate of inflation. The lower this ratio the less painful is disinflation. The new classical approach, pioneered by Lucas (1973), emphasized the variability of nominal GNP growth as a main determinant of the trade-off. The argument is based on the real-nominal confusion of price and output setters, so that agents will be more likely to treat shocks as nominal when the variability of nominal GNP increases. In contrast, the new Keynesian approach, as in Ball, Mankiw and Romer (1988), emphasized the menu costs determinants of the trade-off. That is, in the presence of fixed costs of changing prices, the Phillips curve is expected to be steeper, the higher is the expected rate of inflation, since with higher expected inflation and more frequent price changes, nominal shocks will have smaller real effects.

Keywords: Capital Mobility; Disinflation; Exchange Rate; Mean Inflation; Sacrifice Ratio; Variability of Nominal Income Growth (search for similar items in EconPapers)
JEL-codes: E00 H10 (search for similar items in EconPapers)
Date: 1997-03
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Citations: View citations in EconPapers (11)

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Related works:
Journal Article: Capital mobility and the output-inflation tradeoff (2001)
Working Paper: Capital Mobility and the Output-Inflation Tradeoff (2000)
Working Paper: Capital mobility and the output-inflation tradeoff (1997)
Working Paper: Capital Mobility and the Output-Inflation Tradeoff (1996)
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