Macroeconomics and Finance in Emerging Market Economies - The Portfolio Theory of Inflation and Policy (In)Effectiveness: A Revisit

Jul 19, 2026

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This article revisits the Portfolio Theory of Inflation (PTI) to restate its findings and sharpen their implications for macroeconomic policy in emerging market settings. It strengthens the PTI micro-foundations by formalizing global investors as international allocators of capital and analyzing their interaction with country-level macro policies. The analysis traces how country credibility enters investors’ allocation decisions and how investors’ choices expand or restrict the policy space, shaping whether macroeconomic effects dissipate into exchange-rate depreciation and higher inflation.

LanguageEnglish

CategoryResearch & Report

FormatPDF

Pages39

Reading Time1 h 38 min

Introduction

Portfolio Theory of Inflation (PTI) and policy space

Global investors, credibility, and macro-policy interaction

Public Disclosure Authorized Public Disclosure Authorized Macroeconomics and Finance in Emerging Market Economies THE PORTFOLIO THEORY AND POLICY (IN)EFFECTIVENESS: A REVISITATION | Journal: | Macroeconomics and Finance in Emerging Market Economies | | --- | --- | | Manuscript ID | REME-2021-0131.R2 | | Manuscript Type: | Research article-Macroeconomics and International Finance | | Keywords: | credibility, global investors, policy space | | Abstract: | This article revisits the Portfolio Theory of Inflation (PTI), with a view to further articulating its findings and implications. The article adds to the micro-foundations of the PTI, framing more rigorously the role of global investors as international allocators of capital resources, and providing richer analysis of their interaction with macroeconomic policies at country level. The article explores how country credibility enters the capital allocation choice process of global investors and how global investor choices shape the space available to country policy making, determining the extent to which the effect of macro-policies dissipates into exchange rate depreciation and higher inflation. | | | | URL: [http://mc.manuscriptcentral.com/reme](http://mc.manuscriptcentral.com/reme) [Email: mfeme@igidr.ac.in](Email: mfeme@igidr.ac.in) Page 1 of 38 Macroeconomics and Finance in Emerging Market Economies 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59 60 THE PORTFOLIO THEORY OF INFLATION AND POLICY (IN)EFFECTIVENESS: A REVISITATION 1. INTRODUCTION1 The forces of globalization demand that each country considers realistically how effective its macropolicies can be, given its own characteristics and circumstances. In my recent work on the Portfolio Theory of Inflation (PTI),2 I have analyzed how financial globalization affects the policy space available to authorities at country level – in many cases constraining it to the point of rendering expansionary macro-policies ineffective or even ~~outright~~ destabilizing.3 The issue – one that is especially (though not exclusively) important~~)~~ for developing and emerging market economies – is that despite financial globalization, current macroeconomic policy modelling continues to rely on domestic representative agents and fails to recognize the role~~ global~~ 1 I am hugely ~~wis~~grateful ~~h~~~~to~~~~thank~~to the anonymous referee of this journal for the very helpful comments and suggestions provided to me across the various draft revisions. I would not have been able to realize my intent torevisit, and improve on, my Portfolio Theory of Inflation, without being induced to ponder on and respond to her/his critical and yet very constructive remarks . I am not sure I was eventually able to ~~have~~ convince~~d~~ him/her of the goodness of the approach I propose, but the quality of my article has benefitted greatly. My intellectual indebtedness goes to Willem Buiter and Charles Wyplosz for inspiring me on the importance of intertemporal consistency in the analysis of macroeconomic policy choices and credibility as a factor determining macropolicy effectiveness. ~~ ~~ Obviously, I remain the only responsible for the opinions expressed in the article ~~the article ~~and for any remaining errors. As always~~usual~~, I ~~also want~~ ~~to ~~thank my wife Ornella for her unremitting support. 2 See Bossone (2019 ;, 2020a, b) . 3 The expression "policy space" here refers to the margin ofaction policymakers can use to conduct expansionary fiscal and monetary policy actions ~~ies~~ before these actions ~~y~~threaten the sustainability of public sector liabilities and/or before measures ~~measures ~~become necessary to ensure such sustainability, and eventually undoing the initial policy

FAQs

What does this paper aim to accomplish with the Portfolio Theory of Inflation?

It revisits PTI to further articulate its findings and implications while adding rigor to the theory’s micro-foundations.

How does the paper characterize the role of global investors?

It frames global investors as international allocators of capital whose choices and expectations help determine the value of public sector liabilities.

Through what channel do macroeconomic policies become less effective?

The paper argues that investors’ allocation decisions and country credibility can cause the effects of macro-policies to dissipate into exchange-rate depreciation and higher inflation, limiting policy space.

Jul 19, 2026

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