CAPITAL MOBILITY AND ANTICIPATED INFLATION WITH CASH-IN-ADVANCE CONSTRAINTS

This paper analyzes the impact of inflation on terms of trade and movement of physical capital in a two-country framework, with cash-in-advance constraints. It is shown that (a) domestic inflation and terms of trade are inversely related; (b) an increase in the domestic rate of inflation may increase the domestic capital stock if the terms of trade is highly sensitive to the domestic inflation; (c) the impact of capital movements triggered by inflation largely depend on the substitutability of factors of production. Although the monetary growth affects real variables, the direction and magnitude of such effects depend on the real side of the economy.