MONEY AND IMPORTED INFLATION: AN EMPIRICAL STUDY

Scope of Study. The main purpose of the thesis is to investigate the relevancy of the issue of imported inflation for a small open economy under both fixed and flexible exchange rate systems. The interest is to test if inflation can be imported into a country when exchange rates are fixed and subsequently, whether flexible exchange rates can insulate a country from external shocks and ban the importation of inflation. This study adopts a monetary approach to inflation and a model is constructed for the periods of fixed and flexible exchange rates. The model is tested empirically with the period of fixed exchange rates from 1961 to 1971 and the period of flexible exchange rates from 1972 to 1977. A method of pooling time-series and cross-section data is used for 39 selected countries.; Findings and Conclusions. Empirical results from the study indicate that in a world of fixed exchange rates, inflation is imported through the channels of a balance-of-payments surplus and inflationary expectations from home and abroad. Contrary to the argument that floating exchange rates can insulate a country from international inflation, empirical evidence provided by this study suggests that the international transmission of inflation occurs under both fixed and flexible rates. Floating the rates has not prevented the international transmission of inflation. The mechanisms of transmission under flexible rates are the changes in exchange rates and the expectations on exchange rate changes. It is impossible to tell a priori which exchange rate system is more conducive to world inflation.; The implication of the study is that money plays important role in influencing inflation. In a world of fixed exchange rates, the rate of international inflation is determined by the world money stock. When exchange rates are flexible, the responsibility of world inflation mainly lies on the national monetary policy--the degrees of monetary discipline and government intervention. To restore stability and confidence in the international monetary system, policies should aim at monetary stability and correction of expectations and the problem of international inflation requires both international policy coordination and cooperation.