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Nominal Stability and Financial Globalization

  • Michael B Devereux

    ()

    (University of British Columbia, CEPR and NBER)

  • Ozge Senay

    ()

    (University of St Andrews)

  • Alan Sutherland

    ()

    (University of St Andrews and CEPR)

Over the past four decades, advanced economies experienced a large growth in gross external portfolio positions. This phenomenon has been described as Financial Globalization. Over roughly the same time frame, most of these countries also saw a substantial fall in the level and variability of inflation. Many economists have conjectured that financial globalization contributed to the improved performance in the level and predictability of inflation. In this paper, we explore the causal link running in the opposite direction. We show that a monetary policy rule which reduces inflation variability leads to an increase in the size of gross external positions, both in equity and bond portfolios. This appears to be a robust prediction of open economy macro models with endogenous portfolio choice. It holds across different modeling specifications and parameterizations. We also present preliminary empirical evidence which shows a negative relationship between inflation volatility and the size of gross external positions.

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Paper provided by Department of Economics, University of St. Andrews in its series Discussion Paper Series, Department of Economics with number 201311.

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Date of creation: 30 Sep 2013
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Handle: RePEc:san:wpecon:1311
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