A Model of Growth and Conflict Inflation for a Small Open Economy

Several models of conflict inflation have been developed within the structuralist tradition. This paper differs from such works by assuming full capacity utilization in a small open economy. We introduce the exchange rate as a participant in the theory of inflation and distribution, and analyze two closures: The trade deficit as a market clearing mechanism, and a foreign exchange constrained economy. It is found that wage rigidity and exchange rate flexibility can lead to instability. The main conclusions do not change when we allow for continuous substitution between capital and labor