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Temporary Stabilization with Capital Controls

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  • Singh, Rajesh
  • Subramanian, Chetan

Abstract

This paper studies both positive and normative aspects of quantity-based capital controls in a small open economy undergoing a temporary inflation stabilization plan. In the model, capital controls are implemented by choosing two policy variables: a ceiling on the private sector debt and a terminal date for removing controls; the date on which controls trigger and hence its duration are endogenously determined. Equilibrium dynamics are characterized for all feasible range of debt ceilings and durations. Temporary controls that end with the collapse of the stabilization plan are shown to mitigate consumption boom-bust cycles and dominate allocations under perfect capital mobility, thus providing a "second-best" rationale for employing them. For controls that are prolonged beyond the collapse of the stabilization plan, equilibria exist even when the debt ceiling is above the debt that accumulates under perfect capital mobility. Here, if the ceiling is sufficiently low, controls mitigate consumption cycles. Conversely, a sufficiently high ceiling amplifies consumption cycles. For prolonged controls, there is a critical value of debt ceiling below (above) which the welfare is higher (lower) relative to the perfect capital mobility case. Finally, for a given debt ceiling, prolonged controls rank lower in welfare than those that end with the stabilization plan.

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Bibliographic Info

Paper provided by Iowa State University, Department of Economics in its series Staff General Research Papers with number 12682.

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Date of creation: 01 Mar 2008
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Publication status: Published in Economic Theory, March 2008, vol. 34 no. 3, pp. 545-574
Handle: RePEc:isu:genres:12682

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Postal: Iowa State University, Dept. of Economics, 260 Heady Hall, Ames, IA 50011-1070
Phone: +1 515.294.6741
Fax: +1 515.294.0221
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Web page: http://www.econ.iastate.edu
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  1. Calvo, Guillermo A. & Reinhart, Carmen M. & Vegh, Carlos A., 1995. "Targeting the real exchange rate: theory and evidence," Journal of Development Economics, Elsevier, Elsevier, vol. 47(1), pages 97-133, June.
  2. Sergio Rebelo & Carlos A. Vegh, 1995. "Real Effects of Exchange-Rate-Based Stabilization: An Analysis of Competing Theories," NBER Chapters, in: NBER Macroeconomics Annual 1995, Volume 10, pages 125-188 National Bureau of Economic Research, Inc.
  3. Guidotti, Pablo E. & Vegh, Carlos A., 1992. "Macroeconomic interdependence under capital controls : A two-country model of dual exchange rates," Journal of International Economics, Elsevier, Elsevier, vol. 32(3-4), pages 353-367, May.
  4. Lahiri, Amartya, 2001. "Exchange rate based stabilizations under real frictions: The role of endogenous labor supply," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 25(8), pages 1157-1177, August.
  5. Carmen M. Reinhart & R. Todd Smith, 1996. "Too much of a good thing: the macroeconomic effects of taxing capital inflows," Proceedings, Federal Reserve Bank of San Francisco, Federal Reserve Bank of San Francisco, pages 436-464.
  6. Bacchetta, Philippe, 1990. "Temporary capital controls in a balance-of- payments crisis," Journal of International Money and Finance, Elsevier, Elsevier, vol. 9(3), pages 246-257, September.
  7. Akira Ariyoshi & Andrei Kirilenko & Inci Ötker & Bernard Laurens & Jorge Iván Canales Kriljenko & Karl Friedrich Habermeier, 2000. "Capital Controls," IMF Occasional Papers 190, International Monetary Fund.
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