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On the timing and optimality of capital controls: Public expenditures, debt dynamics and welfare

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  • Raouf Boucekkine
  • Aude Pommeret
  • Fabien Prieur

Abstract

This paper solves a second-best problem where a government has in particular to choose whether to tax financial inflows (capital con- trols) or not, and when. A multi-stage optimal control technique is used to this end. First, it is shown that it is optimal to switch in finite time from capital controls to full financial liberalization (zero tax on capital inflows) whenever a measure of total wealth is above a cer- tain threshold. In particular, a too large initial debt makes financial liberalization sub-optimal. Second, our analysis suggests that capital controls should be used countercyclically: booms should be responded by more financial liberalization while recessions should rather lead to more stringent capital controls. Third, when public expenditure is chosen in order to maximize social welfare, financial liberalization is not unaffordable only for poor countries, even wealthy countries might find it optimal to implement capital controls if they aim to keep a large amount of public expenditure. In short, the preservation of the welfare states might require a more frequent use of capital controls.

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Bibliographic Info

Article provided by The International Society for Economic Theory in its journal International Journal of Economic Theory.

Volume (Year): 9 (2013)
Issue (Month): 1 (03)
Pages: 101-112

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Handle: RePEc:bla:ijethy:v:9:y:2013:i:1:p:101-112

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References

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  1. M. Ayhan Kose & Eswar S. Prasad & Ashley D. Taylor, 2009. "Thresholds in the Process of International Financial Integration," NBER Working Papers 14916, National Bureau of Economic Research, Inc.
  2. Raouf Boucekkine & Patrick Pintus, 2012. "History’s a curse: leapfrogging, growth breaks and growth reversals under international borrowing without commitment," Journal of Economic Growth, Springer, vol. 17(1), pages 27-47, March.
  3. Olivier Jeanne & Anton Korinek, 2010. "Excessive Volatility in Capital Flows: A Pigouvian Taxation Approach," American Economic Review, American Economic Association, vol. 100(2), pages 403-07, May.
  4. Joshua Aizenman & Michael M. Hutchison & Yothin Jinjarak, 2011. "What is the Risk of European Sovereign Debt Defaults? Fiscal Space, CDS Spreads and Market Pricing of Risk," NBER Working Papers 17407, National Bureau of Economic Research, Inc.
  5. Tomiyama, Ken, 1985. "Two-stage optimal control problems and optimality conditions," Journal of Economic Dynamics and Control, Elsevier, vol. 9(3), pages 317-337, November.
  6. Anton Korinek, 2011. "The New Economics of Capital Controls Imposed for Prudential Reasons," IMF Working Papers 11/298, International Monetary Fund.
  7. Raouf Boucekkine & Giorgio Fabbri & Patrick A. Pintus, 2012. "Short-Run Pain, Long-Run Gain : the Conditional Welfare Gains from International Financial Integration," Documents de recherche 12-14, Centre d'Études des Politiques Économiques (EPEE), Université d'Evry Val d'Essonne.
  8. Raouf, BOUCEKKINE & Cagri, SAGLAM & Thomas, VALLEE, 2002. "Technology adoption under embodiment : A two-stage optimal control approach," Discussion Papers (IRES - Institut de Recherches Economiques et Sociales) 2003007, Université catholique de Louvain, Institut de Recherches Economiques et Sociales (IRES).
  9. Kevin Gallagher, 2012. "The Myth of Financial Protectionism: The New (and old) Economics of Capital Controls," Working Papers wp278, Political Economy Research Institute, University of Massachusetts at Amherst.
  10. Raouf Boucekkine & Giorgio Fabbri & Patrick-Antoine Pintus, 2011. "Leapfrogging, Growth Reversals and Welfare," Working Papers halshs-00576743, HAL.
  11. Makris, Miltiadis, 2001. "Necessary conditions for infinite-horizon discounted two-stage optimal control problems," Journal of Economic Dynamics and Control, Elsevier, vol. 25(12), pages 1935-1950, December.
  12. BOUCEKKINE, Raouf & KRAWCZYK, Jacek B. & VALLEE, Thomas, . "Environmental quality versus economic performance: a dynamic game approach," CORE Discussion Papers RP -2335, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
  13. repec:cor:louvrp:2335 is not listed on IDEAS
  14. Raouf Boucekkine & Giorgio Fabbri & Patrick Pintus, 2012. "Short-Run Pain, Long-Run Gain: The Conditional Welfare Gains from International Financial Integration The Conditional Welfare Gains from International Financial Integration," AMSE Working Papers 1202, Aix-Marseille School of Economics, Marseille, France, revised 12 Feb 2012.
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Cited by:
  1. Daria Onori, 2013. "Optimal Growth under Flow-Based Collaterals," AMSE Working Papers 1331, Aix-Marseille School of Economics, Marseille, France, revised 21 May 2013.
  2. Daria Onori, 2013. "Optimal Growth under Flow-Based Collaterals," Working Papers halshs-00824672, HAL.

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