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Capital account liberalization and disinflation in the 1990s

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  • 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

Suggested Citation

  • William C. Gruben & Darryl McLeod, 2001. "Capital account liberalization and disinflation in the 1990s," Center for Latin America Working Papers 0101, Federal Reserve Bank of Dallas.
  • Handle: RePEc:fip:feddcl:0101
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    Cited by:

    1. 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].
    2. Florian Neagu, 2003. "Net Foreign Assets Management and Capital Account Liberalization. The Romanian Case," International Finance 0310002, EconWPA.
    3. 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.
    4. Axel Dreher & Lars-H.R. Siemers, 2003. "The Intriguing Nexus Between Corruption and Capital Account Restrictions," Development and Comp Systems 0306004, EconWPA, revised 07 Jul 2005.
    5. 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.

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