Imported inflation and monetary policy

Abstract

The present paper examines the thesis that monetary policy cannot be used as a weapon against domestic inflation in a surplus country under a regime of fixed exchange rates. The conditions under which the effective execution of domestic monetary policy is hampered by a balance-of-payments surplus are thus examined. The authors restrict their analysis to the case of a European country that is subjected to inflationary pressures because of a capital inflow from the United States. Two kinds of constraints are alleged to hinder the use of monetary policy, internal and external, both of which are considered in turn. The authors find that under certain conditions neither internal nor external constraints vitiate effective monetary action. Moreover, it is argued that the freedom of capital movements in a fixed exchange rate system necessarily eliminates the possibility of connecting national monetary policies.

JEL: E31, E42, E52, F32