Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/195096 
Authors: 
Year of Publication: 
2019
Series/Report no.: 
Economics Discussion Papers No. 2019-29
Publisher: 
Kiel Institute for the World Economy (IfW), Kiel
Abstract: 
The Portfolio Theory of Inflation (PIT) proposed in this study investigates the role of global financial markets in determining the effectiveness of macroeconomic policy in open and fully financial integrated economies. The PIT adopts a modified version of the portfolio balance approach to exchange rate determination and incorporates intertemporal optimal choices from global investors. These investors allocate resources across national economies based on local investment opportunities and policy credibility: when a country's credibility is low, they hold its economy to a tighter intertemporal budget constraint and the issuance of what they deem as "excess" public sector liabilities causes the country's currency to depreciate and inflation to rise due to a large exchange rate pass-through, with limited or no impact on output. On the other hand, high credibility creates space for effective and noninflationary macro policies but, if such space is abused, credibility gets dissipated and higher inflation reflects such dissipation.
Subjects: 
credibility
exchange rate
financial integration
global investor
interest rate
intertemporal budget constraint
money, bonds and assets
pass-through
JEL: 
E31
E4
E5
E62
F31
G15
H3
Creative Commons License: 
cc-by Logo
Document Type: 
Working Paper

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