This presentation is part of: E30-2 Business Fluctuations and Cycles

The Effects of Monetary Policy on Investment, Employment, and Current Account

Kihyun Park, PhD, candidate, Economics, University of Tennessee, 505A Stokely Management Center, Knoxville, TN 37996

    The inflation target has been adopted by many developed and developing countries to stabilize their economies. For over a decade, international economic activities have been gradually integrated. Different impacts from various sectors have been the central issue such as the Dutch disease and the discovery of oil. The effects of the discovery of resources on capital accumulation, output, and terms of trade have effects on both the traded sector and the nontraded sector. It is important to have the nontraded sector because nontraded goods such as infrastructure, roads, housing, and construction play an important role in determining the level of investment and current account balance. By distinguishing between traded and non-traded goods for a small open economy, this setting provides a measure of realism and a more complete general equilibrium view.  

   The objective of this paper is that I show a direct extension of the two-sector dependent economy model into a dynamic optimization framework on the effect of a permanent increase in the inflation rates on the capital accumulation and the current account balance in which money is introduced by a cash-in-advance constraint. I endogenize capital stock and labor-leisure choice offering more flexibility on the supply side and I focus on the fact that the nontraded sector is more capital intensive but I also briefly discuss the other case.

   I show that an increase in the inflation rate has a positive effect on accumulation of capital stock and the current account balance deteriorates. The dynamics depends significantly on the relative capital intensities of two sectors. If a traded good is the more capital intensive, there is no transitional dynamics. By contrast, if a nontraded sector is the more capital intensive, then transitional dynamics can be seen with a change in relative price between consumption goods. Contrary to the conclusion of Stockman (1981) and Mansoorin and Mohsin (2006), higher inflation increases (decreases) the capital accumulation when cash-in-advance constraint is only subject to the tradable (nontradable) consumption goods. As a whole, higher inflation rates will have different effects on employment and output in the traded sector and the nontraded sector.


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