DP4895 Globalization and Disinflation: The Efficiency Channel

Author(s): Prakash Loungani, Assaf Razin
Publication Date: February 2005
Keyword(s): capital-account openness, trade openness, utility-based loss function
JEL(s): E50, F40
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=4895

The paper analyses how globalization forces induce monetary authorities, guided in their policies by the welfare criterion of a representative household, to put greater emphasis on reducing the inflation rate than on narrowing the output gaps. We demonstrate that the marginal rate of substitution between the output gap and the inflation (at a constant value of the utility-based loss function) rises when the economy is opening up to international trade in goods, and is integrated to the world capital markets. We associate the marginal rate of substitution with the sacrifice ratio, and provide evidence on trade and capital openness effects on inflation, through the efficiency channel.