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Trade Openness, Capital Mobility, and the Sacrifice Ratio

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Abstract

This paper develops and evaluates empirically the implications of a theoretical model of an open economy in which variations in both trade openness and capital mobility can influence the sacrifice ratio. Key predictions forthcoming from the model are that both forms of globalization can independently affect the sacrifice ratio, once the influences of the level of central bank independence and the degree of wage stickiness in nations’ economies are taken into account. Examination of cross-country data encompassing 58 disinflations for 16 countries yields evidence consistent with these essential predictions of the theoretical framework.

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Notes

  1. There can be crucial differences between the ultimate policy implications of sticky-price versus sticky-wage models, however, because in the former models a portion of firms in the economy hold prices fixed, typically in light of menu costs, even after monetary policymakers have engaged in policy actions, whereas in the latter models monetary policy actions take place before prices are set, and firms optimally choose not to adjust prices fully in light of wage rigidities.

  2. The derivation of this condition mirrors Benavie (1983). From Eq. 3 the net trade balance is η(p* + s - p) -βy + βy*. If the flow demand for domestic bonds is given by \(b^d = \varphi y^ * + \theta \chi \;{\text{r}} - \theta \varpi \left( {r^ * + s_{ + 1}^e - s} \right) + p^ * + s\), and if the flow demand for foreign bonds is given by \(b^f = \mu y - \theta \vartheta \;{\text{r}} + \theta \upsilon \left( {r^ * + s_{ + 1}^e - s} \right) + p\), then the net domestic capital inflow is defined as \(b^d - b^f = \left( {p^ * + s - p} \right) - \mu y + \theta \kappa \;r - \theta \psi \left( {r^ * + s_{ + 1}^e - s} \right) + \varphi y^ * \), where κ ≡ ϖ + υ and ψ ≡ χ + ϑ. Adding the expression for the trade balance to the net capital inflow yields Eq. 5.

  3. Sacrifice ratios typically are computed using CPI inflation rates, which arguably incorporate effects of exchange-rate variations as well as changes in the domestic price level. Examining the effects of changes in β and θ on \(\frac{{\partial y}}{{\partial s}}\) yields the same prediction regarding the effect greater trade openness on the sacrifice ratio and does nothing to resolve the theoretical ambiguity of the sacrifice-ratio impact of increased capital mobility.

  4. Aizenman and Noy estimate an 87% linear feedback between trade openness and financial openness. The simple bilateral correlation between trade openness and capital mobility in our data is 79%.

  5. One way to deal with the colinearity in our model is to test the joint significance of the related variables. We do so in a model that includes trade and capital as well as their interaction with CBI. In this model, trade and capital are jointly significant with a p-value of 3%. We also combine models 4 and 5 in Table 2 and test the joint significance of capital, capital*Wdur, and capital*CBI. The p-value of the test of joint significance (two-tailed test) is 17%.

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Authors and Affiliations

  1. Department of Economics, Marquette University, Straz Hall, P.O. Box 1881, Milwaukee, WI, 53201-1881, USA

    Joseph P. Daniels

  2. Hankamer School of Business, Baylor University, P.O. Box 8003, Waco, TX, 76798-8003, USA

    David D. VanHoose

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  1. Joseph P. Daniels
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Correspondence to Joseph P. Daniels.

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Daniels, J.P., VanHoose, D.D. Trade Openness, Capital Mobility, and the Sacrifice Ratio. Open Econ Rev 20, 473–487 (2009). https://doi.org/10.1007/s11079-008-9093-5

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