Openness, the sacrifice ratio, and inflation: Is there a puzzle? |
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Authors: | Joseph P Daniels David D VanHoose |
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Institution: | aDepartment of Economics, College of Business Administration, Marquette University, Straz Hall, P.O. Box 1881, Milwaukee, WI 53201, USA;bHankamer School of Business, Baylor University, P.O. Box 8003, Waco, TX 76798-8003, USA |
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Abstract: | The standard time-inconsistency-based explanation for the negative correlation between openness and inflation requires an inverse relationship between the sacrifice ratio and openness, but Daniels et al. (2005, Openness, central bank independence, and the sacrifice ratio. Journal of Money, Credit, and Banking 37 (2), 371–379.) have provided evidence that controlling for central bank independence reveals a positive relationship. This paper embeds the time-inconsistency approach within a model of a multisector, imperfectly competitive, open economy. In this setting, greater openness raises the sacrifice ratio but reduces the inflation bias. Thus, failure to observe an inverse relationship between openness and the sacrifice ratio does not necessarily imply that the time-inconsistency approach is irrelevant to understanding the openness–inflation relationship. |
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Keywords: | Openness Sacrifice ratio Inflation |
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