Discussion Paper

No. 2020-2 | January 08, 2020
The portfolio theory of inflation and policy (in)effectiveness revisited: corroborating evidence


This study revisits and tests empirically the Portfolio Theory of Inflation (PTI), which analyzes how the effectiveness of macroeconomic policy in open and globally financially integrated economies is influenced by global investor decisions (Bossone, The portfolio theory of inflation and policy (in)effectiveness, 2019). The PTI shows that when an economy is heavily indebted and is perceived by the market to be poorly credible, investors hold it to a tighter intertemporal budget constraint and policies aimed to stimulate output growth dissipate into domestic currency depreciation and higher inflation, with limited or no impact on output, or with lower output and lower inflation. On the other hand, markets afford highly credible economies much greater space for effective and noninflationary macro policies. The study leads to a very basic advice: policymakers of an internationally highly integrated economy should keep public liabilities (the stock of both central bank money and public debt) at low levels: the larger the liabilities, the higher the degree of surrender of the country’s national policy sovereignty to external forces and interests.

JEL Classification:

E31, E4, E5, E62, F31, G15, H3


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Cite As

Biagio Bossone and Andrea Cuccia (2020). The portfolio theory of inflation and policy (in)effectiveness revisited: corroborating evidence. Economics Discussion Papers, No 2020-2, Kiel Institute for the World Economy. http://www.economics-ejournal.org/economics/discussionpapers/2020-2

Comments and Questions

Karsten Staehr - Invited Reader Comment
January 30, 2020 - 08:12

The paper elaborates on earlier work by Biagio Bossone on the so-called “portfolio theory of inflation” (PTI). It is probably fair to say that the place of this theory in the overall universe of theories on business cycle and economy policy remains unsettled. This paper provides an extensive presentation of ...[more]

... the theory following by some suggestive empirical evidence.

A key weakness of the paper is that it does not explicate its contribution to science. As a matter of fact, it does not relate PTI to the already very voluminous literature in the fields considered (including e.g. the fiscal theory of inflation). The literature review in Section 2 consists of one paragraph and cites one paper besides Bossone’s own 2019 paper. The literature list is very short and several of the citations are to debate papers or working papers.

The results of the empirical investigation are at best suggestive. It is again symptomatic that no other studies are cited and that the empirical specification is not related to other studies in the literature. The specifications are unrefined and do not appear to address identification issues. Moreover, the splitting of the sample of countries into “high credibility” (HC) and “low credibility” (LC) countries appears subjective and may not be independent of the desired research outcome. There may be other empirical methods that could provide insights into the raised research question.

Karsten Staehr
Tallinn University of Technology, Estonia

Biagio Bossone - Reply to Karsten Staehr's Comments
February 03, 2020 - 09:28

see attached file

Anonymous - Referee Report 1
February 25, 2020 - 11:51

see attached file

Anonymous - Referee Report 2
February 25, 2020 - 11:51

see attached file

Biagio Bossone - Replies to Referee Reports
March 09, 2020 - 08:08

see attached file