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Openness and Inflation: Theory and Evidence

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  • David Romer

Abstract

This paper points out and tests a straight forward but previously unnoticed prediction of models in which the absence of precommitment in monetary policy leads to excessive inflation. Because unanticipated monetary expansion leads to real exchange rate depreciation, and because the harms of real depreciation are greater in more open economies, the benefits of surprise expansion are decreasing in the degree of openness. Thus, under discretionary policy-making, money growth and inflation will be lower in more open economies. After presenting a simple theoretical model demonstrating this prediction of the theory, the paper examines the link between openness and inflation using cross-country data. The data reveal a strong negative link between openness and inflation.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 3936.

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Date of creation: Dec 1991
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Publication status: published as Quarterly Journal of Economics, vol. 108, no. 4, pp. 869-903, November 1993
Handle: RePEc:nbr:nberwo:3936

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  1. Laurence Ball & David Romer, 1987. "Real Rigidities and the Non-Neutrality of Money," NBER Working Papers 2476, National Bureau of Economic Research, Inc.
  2. Driscoll, Michael J & Lahiri, Ashok, K, 1983. "Income-Velocity of Money in Agricultural Developing Economies," The Review of Economics and Statistics, MIT Press, vol. 65(3), pages 393-401, August.
  3. Sheffrin, S.M., 1988. "Two Tests Of Rational Partisan Business Cycle Theory," Papers 54, California Davis - Institute of Governmental Affairs.
  4. Ray C. Fair, 1986. "International Evidence on the Demand for Money," Cowles Foundation Discussion Papers 813, Cowles Foundation for Research in Economics, Yale University.
  5. Alberto Alesina, 1988. "Macroeconomics and Politics," NBER Chapters, in: NBER Macroeconomics Annual 1988, Volume 3, pages 13-62 National Bureau of Economic Research, Inc.
  6. Robert J. Barro & David B. Gordon, 1983. "Rules, Discretion and Reputation in a Model of Monetary Policy," NBER Working Papers 1079, National Bureau of Economic Research, Inc.
  7. Kydland, Finn E & Prescott, Edward C, 1977. "Rules Rather Than Discretion: The Inconsistency of Optimal Plans," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 473-91, June.
  8. Fischer, Stanley, 1990. "Rules versus discretion in monetary policy," Handbook of Monetary Economics, in: B. M. Friedman & F. H. Hahn (ed.), Handbook of Monetary Economics, edition 1, volume 2, chapter 21, pages 1155-1184 Elsevier.
  9. Rogoff, Kenneth, 1985. "The Optimal Degree of Commitment to an Intermediate Monetary Target," The Quarterly Journal of Economics, MIT Press, vol. 100(4), pages 1169-89, November.
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