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Stagflation and Topsy-Turvy Capital Flows

Working Paper 795 | Published January 26, 2023

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Julien Bengui Bank of Canada and CEPR
Louphou Coulibaly University of Wisconsin-Madison
Stagflation and Topsy-Turvy Capital Flows


Are unregulated capital flows excessive during a stagflation episode? We argue that they likely are, owing to a macroeconomic externality operating through the economy’s supply side. Inflows raise domestic wages through a wealth effect on labor supply and cause unwelcome upward pressure on marginal costs in countries where monetary policy is trying to drive down costs to stabilize inflation. Yet, market forces are likely to generate such inflows. Optimal capital flow management instead requires net outflows, suggesting topsy-turvy capital flows following markup shocks.