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The standard time-inconsistency-based explanation for the negative correlation between openness and inflation requires an inverse relationship between the sacrifice ratio and openness, but Daniels et al. (2005, Openness, central bank independence, and the sacrifice ratio. Journal of Money, Credit, and Banking 37 (2), 371–379.) have provided evidence that controlling for central bank independence reveals a positive relationship. This paper embeds the time-inconsistency approach within a model of a multisector, imperfectly competitive, open economy. In this setting, greater openness raises the sacrifice ratio but reduces the inflation bias. Thus, failure to observe an inverse relationship between openness and the sacrifice ratio does not necessarily imply that the time-inconsistency approach is irrelevant to understanding the openness–inflation relationship.

This paper develops a model of an open economy containing both sectors in which wages are market-determined and sectors with wage-setting arrangements. A portion of the latter group of sectors coordinate their wages, taking into account that their collective actions influence the equilibrium inflation outcome in an environment in which the central bank engages in discretionary monetary policymaking. Key predictions forthcoming from this model are (1) increased centralization of wage setting initially causes inflation to increase at low degrees of wage centralization but then, as wage centralization increases, results in an inflation drop-off; (2) a greater degree of centralized wage setting reduces the inflation-restraining effect of greater central bank independence; and (3) increased openness is more likely to reduce inflation in nations with less centralized wage bargaining. Analysis of data for seventeen nations for the period 1970–1999 provides generally robust empirical support for all three of these predictions.

This paper applies a two-country framework that allows for currency substitution in an environment in which policymakers optimally vary interest rates in light of utility-based objectives, one country pegs the value of its currency to the other nation’s currency, and government revenue is generated via explicit taxes and seigniorage. The analysis illustrates the roles that currency substitution, currency preferences, and efficiency of tax systems play in contributing to the likelihood of a “run” on one nation’s currency. We explore how these factors interact to influence the probability of a currency crisis in the country that fixes its exchange rate.

In this paper, a two-country leader-follower model with imperfect asset substitution is used to derive the optimal sterilization coefficients for two-country flexible and fixed exchange rate regimes. It is found that, in general, incomplete sterilization is optimal. However, both the origin and the type of macroeconomic shocks the economies experience are important in determining the appropriate degree of sterilization. We also find that sterilization policies have spill-over effects (strategic complements) in both cases. Thus, in a competitive policy-making environment, greater sterilization by one country leads to greater sterilization by the other country. Further, the impact of increasing capital market integration is examined in particular. We show that greater integration compounds this problem, leading to full sterilization as the optimal outcome under perfect capital mobility.

Most nations have experienced ‘base drift’ of their money stocks and associated price-level non-trend-stationarities. Recent explanations for this fact have emphasized tensions among various possible objectives of central banks in closed-economy or small-open-economy frameworks. In contrast, this paper explores structural and policy interdependence among economies as an explanation for price-level non-trend-stationarities. It demonstrates that such interdependence can induce central banks to follow non-trend-stationary policies even if they desire only to smooth prices in their home economies.