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Capital account liberalization and disinflation in the 1990s

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Listed author(s):
  • William C. Gruben
  • Darryl McLeod

Abstract

As a way of addressing arguments in the literature (Rodrik, 1998) that the act of capital account liberalization leads to inflation, we present a simple theoretical model in which capital account liberalization raises the absolute value of the elasticity of money demand because agents have broader money holding options than under a closed capital account. The central bank maximizes seigniorage, balancing the benefits of higher inflation against potential losses of foreign currency reserves. The optimum seigniorage-maximizing rate of inflation falls when capital controls are loosened, as a result of the impact of liberalization on the elasticity of money demand. In a series of OLS and instrumental variables models that are heavily influenced by the work of Romer (1993) on current account openness and Grilli and Milesi-Ferretti (1995) on capital account openness, we test the impact of the act capital account liberalization (and many other factors) on inflation and find results that are consistent with our simple theoretical model and that are inconsistent with the recent work of Rodrik (1998). ; Economic Research Working Paper 0104

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Paper provided by Federal Reserve Bank of Dallas in its series Center for Latin America Working Papers with number 0101.

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Date of creation: 2001
Handle: RePEc:fip:feddcl:0101
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  1. Barro, Robert J & Gordon, David B, 1983. "A Positive Theory of Monetary Policy in a Natural Rate Model," Journal of Political Economy, University of Chicago Press, vol. 91(4), pages 589-610, August.
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  5. Michael W. Klein & Giovanni Olivei, 1999. "Capital Account Liberalization, Financial Depth and Economic Growth," NBER Working Papers 7384, National Bureau of Economic Research, Inc.
  6. Eliana Cardoso & Ilan Goldfajn, 1998. "Capital Flows to Brazil: The Endogeneity of Capital Controls," IMF Staff Papers, Palgrave Macmillan, vol. 45(1), pages 161-202, March.
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  8. Marta Campillo & Jeffrey A. Miron, 1997. "Why Does Inflation Differ across Countries?," NBER Chapters,in: Reducing Inflation: Motivation and Strategy, pages 335-362 National Bureau of Economic Research, Inc.
  9. Robert J. Barro & Paul Romer, 1993. "Economic Growth," NBER Books, National Bureau of Economic Research, Inc, number barr93-1, June.
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  12. Dani Rodrik & Andres Velasco, 1999. "Short-Term Capital Flows," NBER Working Papers 7364, National Bureau of Economic Research, Inc.
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  14. Richard N. Cooper, 1999. "Should Capital Controls be Banished?," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 30(1), pages 89-142.
  15. Eliana Cardoso, 1992. "Inflation and Poverty," NBER Working Papers 4006, National Bureau of Economic Research, Inc.
  16. Cukierman, Alex & Webb, Steven B & Neyapti, Bilin, 1992. "Measuring the Independence of Central Banks and Its Effect on Policy Outcomes," World Bank Economic Review, World Bank Group, vol. 6(3), pages 353-398, September.
  17. Davidson, Russell & MacKinnon, James G., 1993. "Estimation and Inference in Econometrics," OUP Catalogue, Oxford University Press, number 9780195060119.
  18. José de Gregorio, 1999. "Financial integration, financial development and economic growth," Estudios de Economia, University of Chile, Department of Economics, vol. 26(2 Year 19), pages 137-161, December.
  19. Lane, Philip R., 1997. "Inflation in open economies," Journal of International Economics, Elsevier, vol. 42(3-4), pages 327-347, May.
  20. Cukierman, Alex & Edwards, Sebastian & Tabellini, Guido, 1992. "Seigniorage and Political Instability," American Economic Review, American Economic Association, vol. 82(3), pages 537-555, June.
  21. 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 473-491, June.
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Cited by:

  1. Florian Neagu, 2003. "Net Foreign Assets Management and Capital Account Liberalization. The Romanian Case," International Finance 0310002, EconWPA.
  2. Axel Dreher & Lars-H.R. Siemers, 2003. "The Intriguing Nexus Between Corruption and Capital Account Restrictions," Development and Comp Systems 0306004, EconWPA, revised 07 Apr 2004.
  3. Igor Da Silva Veiga & Helder Ferreira De Mendonça, 2014. "Financial Openness And Inflationtargeting: An Analysis For The Unpleasant Fiscal Arithmetic," Anais do XL Encontro Nacional de Economia [Proceedings of the 40th Brazilian Economics Meeting] 059, ANPEC - Associação Nacional dos Centros de Pósgraduação em Economia [Brazilian Association of Graduate Programs in Economics].
  4. de Mendonça, Helder Ferreira & da Silva Veiga, Igor, 2014. "A Note On Openness And Inflation Targeting: Implications For The Unpleasant Fiscal Arithmetic," Macroeconomic Dynamics, Cambridge University Press, vol. 18(05), pages 1187-1207, July.
  5. Lekshmi Nair, 2012. "Policy Disciplining Effect of Capital Account Openness in India," Transition Studies Review, Springer;Central Eastern European University Network (CEEUN), vol. 19(1), pages 43-57, September.

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