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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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  • Van Der Ploeg & A., 1989. "Capital Accumulation, Inflation And Long-Run Conflict In International Objectives," Papers 8904, Tilburg - Center for Economic Research.
  • Handle: RePEc:fth:tilbur:8904
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    1. Buiter, Willem H, 1981. "The Superiority of Contingent Rules over Fixed Rules in Models with Rational Expectations," Economic Journal, Royal Economic Society, vol. 91(363), pages 647-670, September.
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    5. Stanley Fischer & Franco Modigliani, 1978. "Towards an understanding of the real effects and costs of inflation," Review of World Economics (Weltwirtschaftliches Archiv), Springer;Institut für Weltwirtschaft (Kiel Institute for the World Economy), vol. 114(4), pages 810-833, December.
    6. 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 402-423, June.
    7. David Currie & Paul Levine, 1985. "Macroeconomic Policy Design in an Interdependent World," NBER Chapters,in: International Economic Policy Coordination, pages 228-273 National Bureau of Economic Research, Inc.
    8. Carlo Carraro & Francesco Giavazzi, 1988. "Can International Policy Coordination Really Be Counterproductive?," NBER Working Papers 2669, National Bureau of Economic Research, Inc.
    9. Dornbusch, Rudiger & Fischer, Stanley, 1980. "Exchange Rates and the Current Account," American Economic Review, American Economic Association, vol. 70(5), pages 960-971, December.
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    Keywords

    inflation ; exchange rate;

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