Working Paper: CEPR ID: DP17661
Authors: Julien Bengui; Louphou Coulibaly
Abstract: Over the latest monetary policy tightening cycle, capital has been flowing from jurisdictions with the least aggressive hiking profiles to those with the most aggressive ones. This pattern of capital flows is consistent with the predictions of a standard open-economy model with nominal rigidities where cost-push shocks generate an inflationary episode and capital flows freely across countries. Yet, by raising demand for domestic non-tradable goods and services, capital inflows cause unwelcome upward pressure on firms' costs in countries most severely hit by these shocks. We argue that a reverse pattern of capital flows would have improved the output-inflation trade-off globally, hence requiring a less aggressive monetary tightening in the most severely hit countries and delivering overall welfare gains.
Keywords: cost-push shocks; current account adjustment; externalities; capital flow management
JEL Codes: E32; E44; E52; F32; F41; F42
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Capital inflows (F21) | Demand for domestic nontradable goods (R22) |
| Demand for domestic nontradable goods (R22) | Firms' marginal costs (D21) |
| Firms' marginal costs (D21) | Inflation (E31) |
| Capital inflows (F21) | Firms' marginal costs (D21) |
| Firms' marginal costs (D21) | Central bank's policy tradeoff (E52) |
| Central bank's policy tradeoff (E52) | Need for tighter monetary policy (E52) |
| Capital inflows (F21) | Inflation (E31) |