Capital mobility and the output-inflation tradeoff

Our paper analyses the effects of restrictions on capital mobility on the output-inflation tradeoff. 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 tradeoff 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 tradeoff 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 tradeoff 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 tradeoff parameter.