The Inflationary Bias in a Model of the Open Economy
Abstract: In this paper we highlight the importance of aggregate supply effects on the size of the inflationary bias under discretionary policy-making. Using a simple model of an open economy that imports a foreign resource input, we show that under discretion the inflationary bias bears an inverse relationship to the elasticity of output supplied with respect to the real exchange rate. This theoretical finding is consistent with Romer's (1993) empirical results that point to the existence of a negative association between openness and inflation.
Key Words: Inflationary Bias, Discretionary Monetary Policy, Open Economy.
JEL Classification: E5 F4