Background:

Several Kaleckian models have tackled the interaction between economic growth and functional income distribution in open economies. However, this type of models usually omits the effects of external public and private indebtedness on developing economies such as Latin America.

Methodology:

We develop an extended Kaleckian model that includes external indebtedness, which allows us to identify the transmission channels from exogenous factors that influence capital flows in key macroeconomic variables: Nominal exchange rates, functional income distribution, inflation rate, and economic growth. The model is relevant for the analysis of the macroeconomic context of Latin America and other developing and emerging economies.

Results:

This work extends the traditional demand regimes of Kaleckian models, by taking into account the effects of external indebtedness on functional income distribution via regimes led by the exchange rate and regimes led by external debt services. Taxes on capital and labor can be used as an instrument to reduce distributive conflict inherent in price and wage setting in economies dependent on external financing, and subject to significant exchange rate fluctuations.

Conclusions:

An economy open to capital flows can experience severe changes in wage income shares and economic activity. In the short-term, appreciating pressures on the nominal exchange rate reduces inflation and the cost of external indebtedness for firms, which is later compensated by the growing weight of external debt and debt servicing, fostering inequality and leading to aggregate demand stagnation. We propose the implementation of tax-based income policies to isolate the process of price and wage setting from changes in external indebtedness and the nominal exchange rate.