Our paper analyses the effects of restrictions on capital mobility on the
output-inflation tradeoff. Using a stochastic version of the Mundell-Fleming
model, we establish a theoretical presumption that an increase in restrictions
on capital mobility should make the tradeoff parameter smaller, that is, a
given change in the inflation rate should be associated with smaller movements
in output. To measure the extent to which countries restrict capital
movements, we construct an index using data from the IMF's Annual Report on
Exchange Rate Arrangements and Exchange Restrictions. The estimates of the
output-inflation tradeoff parameter are obtained from studies by Lucas
(1973), Ball, Mankiw and Romer (1988) and others. Consistent with the
theoretical presumption, countries with greater restrictions on capital
controls have a smaller tradeoff parameter, that is, a steeper Phillips curve.
This result holds after controlling for the impact of variability of
aggregate demand [as suggested by Lucas (1973)] and mean inflation [as
suggested by Ball, Mankiw and Romer (1988)] on the tradeoff parameter.
Full paper (458 KB PDF)
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