Working Paper: CEPR ID: DP1252
Authors: Assaf Razin; Chiwa Yuen
Abstract: It is well known that in the Mundell-Fleming model capital mobility creates a channel through which permanent (transitory) shocks to aggregate demand such as fiscal and trade shocks are completely (partially) neutralized by the response of the real exchange rate. An important policy implication of the model which has gone largely unnoticed is how the transmission of these shocks under different degrees of capital mobility may alter the inflation-unemployment trade-off, i.e. the Phillips Curve. In the context of the stochastic Mundell-Fleming model we show that capital controls reduce the output/employment variations at the expense of larger variations in inflation rates. When policy-makers put more weight on stable employment rather than stable inflation, their objectives can thus be attained more easily under capital controls.
Keywords: inflation-unemployment tradeoff; capital controls; stochastic Mundell-Fleming model; supply shock; demand shock; money shock
JEL Codes: E24; F21; F32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Capital Controls (F38) | Phillips Curve Steepness (E31) |
| Capital Controls (F38) | Variation in Unemployment Rates (J64) |
| Capital Controls (F38) | Variation in Inflation Rates (E31) |
| Capital Controls (F38) | Response of Output to Demand Shocks (E39) |
| Capital Controls (F38) | Stability of Employment Objectives (J63) |
| Phillips Curve Steepness (E31) | Variation in Unemployment Rates (J64) |
| Phillips Curve Steepness (E31) | Variation in Inflation Rates (E31) |