Capital Mobility and the Output-Inflation Trade-Off

Our paper analyzes the effects of restrictions on capital mobility on the output-inflation trade-off. Using a stochastic version of the Mundell-Fleming model, we establish a theoretical presumption that an increase in restrictions on capital mobility should make the trade-off parameter smaller; that is, a given change in the inflation rate should be associated with smaller movements in output. To measure the extent to which countries restrict capital movements, we construct an index using data from the IMF's Annual Report on Exchange Rate Arrangements and Exchange Restrictions. The estimates of the output-inflation trade-off parameter are obtained from studies by Lucas (1973), Ball, Mankiw and Romer (1988) and others. Consistent with the theoretical presumption, countries with greater restrictions on capital controls have a smaller trade-off parameter, that is, a steeper Phillips curve. This result holds after controlling for the impact of variability of aggregate demand (as suggested by Lucas (1973)) and mean inflation (as suggested by Ball, Mankiw and Romer (1988)) on the trade-off parameter