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Capital Flows and Monetary Policy

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Author Info
Javier Gómez Pineda ()
Abstract

Capital flows often confront central banks with a dilemma: to contain the exchange rate or to allow it to float. To tackle this problem, an equilibrium model of capital flows is proposed. The model captures sudden stops with shocks to the country risk premium. This enables the model to deal with capital outflows as well as capital inflows. From the equilibrium conditions of the model, I derive an expression for the accounting of net foreign assets, which helps study the evolution of foreign debt under di¤erent policy experiments. The policy experiments point to three main conclusions. First, interest rate defenses of the exchange rate can deliver recessions during capital outflows even in financially resilient economies. Second, during unanticipated reversals in capital inflows, the behavior of foreign debt is not necessarily improved by containing the exchange rate. Third, an economy can gain resilience not by simply shifting the currency denomination of debt, but by both, shifting the denomination and floating the currency.

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Paper provided by Banco de la Republica de Colombia in its series Borradores de Economia with number 395.

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Handle: RePEc:bdr:borrec:395

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Related research
Keywords: Sudden stops; Credit booms; Country risk; Fear of floating; Debt sustainability;

Find related papers by JEL classification:
F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
H62 - Public Economics - - National Budget, Deficit, and Debt - - - Deficit; Surplus
H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management

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