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Capital Accumulation, Inflation And Long-Run Conflict In International Objectives


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It is shown that, when there is a genuine long-run trade-off between inflation and output, coordination under pre-commitment yields substantial improvements in economic welfare. The analysis is conducted within the context of a two-country model with capital accumulation, immobile labour, perfect capital mobility and floating exchange rates. If the home government increases its monetary growth rate, it increases home inflation, reduces the world real interest rate and therefore boosts both home and foreign capital accumulation. The foreign country thus enjoys a gain in output without suffering from higher inflation. Competitive policies lead to monetary policies which are too tight and levels of activity which are too low, since each country attempts to be a "free rider". Coordination leads to a lower world real interest rate and higher welfare. Pre-commitment is necessary, for the success of coordinated policies, however. Otherwise each government has an incentive to renege and levy a "surprise" inflation tax. In the absence of binding contracts or reputation effects, both cooperation and competitive policy formulation lead to excessive monetary growth rates and higher levels of activity than under coordination or competition with pre-commitment. Coordination can be futile, since it exacerbates the lack of credibility perceived by the private sectors.

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Bibliographic Info

Paper provided by Tilburg - Center for Economic Research in its series Papers with number 8904.

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Length: 31 pages
Date of creation: 1989
Date of revision:
Handle: RePEc:fth:tilbur:8904

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Keywords: inflation ; exchange rate;

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Cited by:
  1. Ploeg, F. van der, 1990. "Macroeconomic policy coordination during the various phases of economic and monetary integration in Europe," Discussion Paper 1990-61, Tilburg University, Center for Economic Research.
  2. Var Der Ploeg, F., 1989. "Monetary Interdependence Under Alternative Exchange-Rate Regime," Papers 8920, Tilburg - Center for Economic Research.


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