Investment, output and interest rate policy when capital is mobile

The determination of long-run aggregate supply is a feature which short-run models of macroeconomic policy coordination tend to neglect but which has implications for the setting of interest rates. In this paper we develop an open-economy model of output maximisation, where investment and capital flows are crucial determinants of output and are in turn influenced by interest rate policy and credible control of inflation. The model represents an extension to short-run models of government policy-making, and emphasises that coordination of relative interest rates is as important as control of inflation.