This paper develops a two‐country general equilibrium model to analyze the optimal rate of inflation under discretion. When agents' welfare is the sole policy objective it is possible to show that openness and inflation no longer have a simple inverse relationship. Because the terms of trade are related to monopoly markups, a greater degree of openness may lead the policymaker to exploit the short‐run Phillips curve more aggressively, even if it involves a smaller short‐run benefit. Inflation can then be higher in a more open economy.
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Dudley Cooke (2010) studied this question.
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