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Capital controls as an instrument of monetary policy

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  • Davis, Scott

    ()
    (Federal Reserve Bank of Dallas)

  • Presno, Ignacio

    ()
    (Federal Reserve Bank of Boston)

Abstract

Large swings in capital flows into and out of emerging markets can potentially lead to excessive volatility in asset prices and credit supply. In order to lessen the impact of capital flows on financial instability, a number of researchers and policy markers have recently proposed the use of capital controls. This paper considers the benefit of adding capital controls as a potential instrument of monetary policy in a small open economy. In a DSGE framework, we find that when domestic agents are subject to collateral constraints and the value of collateral is subject to fluctuations driven by foreign capital inflows and outflows, the adoption of temporary capital controls can lead to a significant welfare improvement. The benefits of capital controls are present even when monetary policy is determined optimally, implying that there may be a role for capital controls to exist side-by-side with conventional monetary tools as an instrument of monetary policy.

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Bibliographic Info

Paper provided by Federal Reserve Bank of Dallas in its series Globalization and Monetary Policy Institute Working Paper with number 171.

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Length: 36 pages
Date of creation: 01 Feb 2014
Date of revision:
Handle: RePEc:fip:feddgw:171

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  1. Nicolas E. Magud E. & Carmen M. & Kenneth S. Rogoff, 2011. "Capital Controls: Myth and Reality--A Portfolio Balance Approach," Working Paper Series, Peterson Institute for International Economics WP11-7, Peterson Institute for International Economics.
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  7. Gianluca Benigno & Huigang Chen & Christopher Otrok & Alessandro Rebucci & Eric Young, 2013. "Capital Controls or Real Exchange Rate Policy? A Pecuniary Externality Perspective," Research Department Publications, Inter-American Development Bank, Research Department IDB-WP-393, Inter-American Development Bank, Research Department.
  8. Graciela L. Kaminsky & Carmen M. Reinhart & Carlos A. Végh, 2005. "When It Rains, It Pours: Procyclical Capital Flows and Macroeconomic Policies," NBER Chapters, in: NBER Macroeconomics Annual 2004, Volume 19, pages 11-82 National Bureau of Economic Research, Inc.
  9. Michael W. Klein, 2012. "Capital Controls: Gates versus Walls," NBER Working Papers 18526, National Bureau of Economic Research, Inc.
  10. Arnaud Costinot & Guido Lorenzoni & Iván Werning, 2011. "A Theory of Capital Controls as Dynamic Terms-of-Trade Manipulation," NBER Working Papers 17680, National Bureau of Economic Research, Inc.
  11. Stephanie Schmitt-Grohe & Martin Uribe, 2012. "Prudential Policy for Peggers," NBER Working Papers 18031, National Bureau of Economic Research, Inc.
  12. Olivier Jeanne & Anton Korinek, 2010. "Excessive Volatility in Capital Flows: A Pigouvian Taxation Approach," American Economic Review, American Economic Association, American Economic Association, vol. 100(2), pages 403-07, May.
  13. Matteo Iacoviello, 2005. "House Prices, Borrowing Constraints, and Monetary Policy in the Business Cycle," American Economic Review, American Economic Association, American Economic Association, vol. 95(3), pages 739-764, June.
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  15. Chikako Baba & Annamaria Kokenyne, 2011. "Effectiveness of Capital Controls in Selected Emerging Markets in the 2000's," IMF Working Papers 11/281, International Monetary Fund.
  16. Dixit, Avinash K & Stiglitz, Joseph E, 1975. "Monopolistic Competition and Optimum Product Diversity," The Warwick Economics Research Paper Series (TWERPS) 64, University of Warwick, Department of Economics.
  17. Andrés Fernández & Alessandro Rebucci & Martín Uribe, 2013. "Are Capital Controls Prudential? An Empirical Investigation," NBER Working Papers 19671, National Bureau of Economic Research, Inc.
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