Anti-Inflationary Monetary Policy and the Capital Import Tax
Anti-inflationary monetary policy faces special problems under flexible exchange rate and free capital movements. While this policy might be quite effective in reducing inflation it is also likely to create changes in relative prices which can be undesirable. In particular the short run capital imports which are introduced by the restrictive policy may bias the deflationary effect towards the exchange rate and thus lead to its appreciation in real terms. While this phenomenon may be temporary it may cause cufficient concern in an export oriented economy.
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