Working Paper: NBER ID: w0713
Authors: Alan C. Stockman
Abstract: This paper examines the relationship between inflation, exchange rates, and the pattern of international trade and payments in a small economy with utility-maximizing agents and a transactions demand for money. Fully anticipated inflation has real effects in the model through its role as a tax on money and thereby on monetary transactions. An increase in the rate of monetary expansion generally reduces the value of domestic output and alters the composition of domestic production. The result is a change in the pattern of international comparative advantage and trade flows. The initial depreciation of the exchange rate following an increase in the rate of monetary expansion is accompanied by a trade surplus and capital outflow, while the subsequent depreciation is accompanied by a trade deficit.
Keywords: inflation; exchange rates; international trade; monetary policy
JEL Codes: E31; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| inflation (E31) | monetary transactions (E42) |
| monetary transactions (E42) | domestic output (E23) |
| rate of monetary expansion (E50) | exchange rate depreciation (F31) |
| exchange rate depreciation (F31) | trade surplus (F14) |
| trade surplus (F14) | capital outflow (F21) |
| exchange rate depreciation (F31) | trade deficit (F14) |
| inflation (E31) | trade flows (F10) |
| rate of monetary expansion (E50) | trade flows (F10) |