In this paper we present a heterodox

In this paper we present a heterodox open-economy macroeconomic model that seeks to establish an alternative view to the “New Consensus” model and analyze the determinants of long-run inflation, the transmission straight from the source of monetary policy, the costs of such policy and its limitations. The structure of the model intends to be simple, in order to be comparable to the new consensus model. We will analyze an open-economy were inflation is a cost-push phenomenon and the monetary authority can manage the nominal exchange rate through changes in interest rate differentials. In this model we will incorporate an explicit inflation target regime in the sraffian supermultiplier model in order to analyze how economic policy can influence the growth rate of productive capacity and the Functional income distribution.
An alternative model to the open-economy “new consensus”
The model closure and analytical solution To close our model we need to establish how the interest rate is determined. We suppose, as in the new consensus model, that the monetary authority set the nominal interest rate in order to achieve inflation target (π). The Monetary Authority raises the nominal interest rate when inflation is above target, and lowers when it is below: In order to obtain the analytical solution, we depart from the Phillips curve (Equation 14). The long run inflation will depend on the permanent pressures on inflation. Demand shocks, as we discuss, are temporary as the productive capacity adjusts to the current output level. In the long run, this source of pressure disappears. Cost-push shocks such as changes in nominal interest rates (Δi) are also temporary, since there is a nominal interest rate (i=i) that is capable of achieving inflation target. So, in the long run we do not expect changes in the nominal interest rate. Consequently, in the long run, inflation will depend on international inflation, changes in nominal exchange rate, on the degree of distributive conflict “c” and on the inflation inertia degree: We have the following system to solve: From Eq. (24) we can deduce that, given international inflation, the share of imported inputs, inflation inertia degree and workers’ bargaining power c, there is a change in nominal exchange rate that can bring long run inflation to the target. To achieve this exchange rate change, the monetary authority must set domestic interest rate above international rate. We will denote the domestic interest rate necessary to change nominal exchange rate and thus to bring long run inflation to the target as (i). Replacing Eq. (24) in (22) and as if π=π→i=i, we have: Thus, the domestic interest rate necessary to change nominal exchange rate and thus to bring long run inflation to the target (i) will be: As we can see, there is an inverse relation between nominal interest rates and the inflation target. The slope of this relation depends on the inflation inertia degree “a”, m* and l*c, while the position depends on international conditions (πw, (iw+ρ), F′/δ). Replacing i and π in Eq. (6) we find the growth rate of autonomous expenditures (z) Eq. (27) shows us that there is a positive relation between the growth rate of autonomous spending (z) and inflation target. So, the higher is inflation target, the higher will be growth rate of the growth rate of autonomous spending. Finally, the growth rate of productive capacity will be the result of both autonomous spending and the multiplier, whith the latter changing as consequence of variations in functional income distribution, according to Eq. (9) and (15).
Numerical simulations In the numerical simulation exercise, the extreme hypothesis of h=1 in the adaptive exchange rate expectation (20) is abandoned and the exchange rate expectations now depends on an average weight of past exchange rate. The initial condition, parameters and exogenous variables supposed are: (a) inflation starts at 6%; (b) First exchange rate expectations is 4,0 and the parameter h is 0,76; (c) International interest rate is 5% and sovereign spread is 2%; (d) initial domestic nominal interest rate is 20%; (d) Output and productive capacity initial levels are in equilibrium and are equal to 400; (e) Exogenous component of growth rate of autonomous expenditures, σ is 8%; (f) The monetary authority\'s rule parameter γ is 0,7; (g) a high value of δ, denoting that short run capital flows are highly sensitive to interest rate differentials. All the simulations start with the same initial conditions.