The Non-Neutrality of Inflation for International Capital Movements
This paper studies the question of how unilateral changes in the rate of inflation affect the
international allocation of capital. Presenting a model that incorporates a transaction
motive for money holding and capital income taxation with historical cost accounting, it
counters the view that inflation will be neutral in a world of perfect foresight and costless
arbitrage: under mild conditions, domestic inflation will unambiguously induce a capital
export. The paper includes a discussion of the Fisher effect. The empirical observation of a
less than one-to--one translation of inflation into nominal interest rates is shown to be
compatible with the model, and in fact the capital export turns out to be stronger the
lower the degree of translation.
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