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

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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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
Contact details of provider: Postal: TILBURG UNIVERSITY, CENTER FOR ECONOMIC RESEARCH, 5000 LE TILBURG THE NETHERLANDS.
Phone: 31 13 4663050
Fax: 31 13 4663066
Web page: http://center.uvt.nl/Email:


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  1. repec:nbr:nberre:0126 is not listed on IDEAS
  2. Willem H. Buiter, 1981. "The Superiority of Contingent Rules over Fixed Rules in Models with Rational Expectations," NBER Technical Working Papers 0009, National Bureau of Economic Research, Inc.
  3. Carlo Carraro & Francesco Giavazzi, 1988. "Can International Policy Coordination Really Be Counterproductive?," NBER Working Papers 2669, National Bureau of Economic Research, Inc.
  4. Barro, Robert J., 1974. "Are Government Bonds Net Wealth?," Scholarly Articles 3451399, Harvard University Department of Economics.
  5. Begg, David K H, 1980. "Rational Expectations and the Non-neutrality of Systematic Monetary Policy," Review of Economic Studies, Wiley Blackwell, vol. 47(2), pages 293-303, January.
  6. Dornbusch, Rudiger & Fischer, Stanley, 1980. "Exchange Rates and the Current Account," American Economic Review, American Economic Association, vol. 70(5), pages 960-71, December.
  7. Aizenman, Joshua & Frenkel, Jacob A, 1985. "Optimal Wage Indexation, Foreign Exchange Intervention, and Monetary Policy," American Economic Review, American Economic Association, vol. 75(3), pages 402-23, June.
  8. Stanley Fischer & Franco Modigliani, 1978. "Towards An Understanding of the Real Effects and Costs of Inflation," NBER Working Papers 0303, National Bureau of Economic Research, Inc.
  9. Taylor, John B, 1980. "Aggregate Dynamics and Staggered Contracts," Journal of Political Economy, University of Chicago Press, vol. 88(1), pages 1-23, February.
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