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A new approach to capital control for emerging market economies

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  • Garcia-Barragan, Fernando
  • Liu, Guangling

Abstract

The present paper proposes a new approach to capital control for emerging market economies, which restricts capital inflows to a fraction of the gap between foreign currency denominated loans and deposits in the economy. We show that the foreign-currency-gap capital control proposed here outperforms tax-based capital control in attenuating the negative effects of external shocks on business cycle fluctuations. This attenuation effect works via the interest rate channel and the capital control constraint itself. Compared to tax-based capital control, the foreign-currency-gap capital control is welfare enhancing, effectively mitigating financial instability with little cost in terms of macroeconomic stability. Countries with a high level of foreign currency denominated loans and deposits need to implement a stricter foreign-currency-gap capital control.

Suggested Citation

  • Garcia-Barragan, Fernando & Liu, Guangling, 2022. "A new approach to capital control for emerging market economies," The North American Journal of Economics and Finance, Elsevier, vol. 61(C).
    • Handle: RePEc:eee:ecofin:v:61:y:2022:i:c:s106294082200050x
    DOI: 10.1016/j.najef.2022.101696
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    More about this item

    Keywords

    Capital control; Foreign currency denomination; Open economy macroeconomics; Financial friction; Welfare analysis; Emerging market economy; DSGE;
    All these keywords.

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • F38 - International Economics - - International Finance - - - International Financial Policy: Financial Transactions Tax; Capital Controls
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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