Flattened Inflation-Output Tradeoff and Enhanced Anti-Inflation Policy as an Equilibrium Outcome of Globalization

Abstract

This working paper was written by Alon Binyamini (Tel Aviv University and Bank of Israe) and Assaf Razin (Tel Aviv University, Cornell University, National Bureau of Economic Research, Centre for Economic Policy Research and Cesifo).

The paper provides a unified analysis of globalization effects on the inflation-output tradeoff and monetary policy, in the New-Keynesian framework. The main proposition of the paper is threefold. First, labor, goods, and capital mobility tend to flatten the tradeoff between inflation and activity. Second, these globalization forces lead monetary policy to be more aggressive with regard to inflation fluctuations but, at the same time, more benign with respect to the output-gap fluctuations, when policy makers are guided by the welfare criterion of the representative household. Third, the equilibrium response of inflation to supply and demand shocks is more moderate, and the equilibrium response of the output gap to these shocks is more pronounced, when the economy opens up.

Keywords: New-Keynesian Phillips curve, Migration, Trade in goods, Trade in financial assets, Interest rate policy rule

JEL Classification: E50, F30, F22