Does Capital Account Openness Lower Inflation? -Abhijit Sen Gupta

This study reviewed the degree of capital account liberalization in developed and developing economies during the last 25 years and analysed the impact on inflation rates in these economies. It developed a theoretical model which argued that an increase in capital account liberalization would lead to lower inflation. The study also tested the predictions of the theoretical model by using empirical methods involving static and dynamic panel data analysis.

The study found that widespread capital account liberalization during the last two decades appears to have contributed to the worldwide disinflation observed during the same period. The threat of capital outflow in the face of loose monetary policy acts as a strong deterrent for such policies. Focusing specifically on the Indian case, it concluded that financial integration since the mid 90s has exercised some degree of “disciplinary effect” and helped to curb inflation.