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How do Capital Controls Affect the Transmission of Foreign Shocks?

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  • Dudley Cooke

    (University of Essex)

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    Abstract

    This paper studies the short-run transmission of foreign shocks in a small open economy with capital controls and a fixed exchange rate. Capital controls alter the transmission of shocks because endogenous changes in the domestic nominal interest rate affect savings and investment decisions. The economy's reaction to export shocks hinges on how the government chooses to restrict capital flows; that is, whether inflows or outflows are restricted. For foreign interest rate shocks, private capital flows are important, but so are the government's holdings of foreign exchange reserves. Finally, a simple graphical apparatus is developed to provide a contrast to the case when capital flows are unrestricted.

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    File URL: http://www.econ.ku.dk/eprn_epru/Workings_Papers/wp-07-02.pdf
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    Bibliographic Info

    Paper provided by Economic Policy Research Unit (EPRU), University of Copenhagen. Department of Economics in its series EPRU Working Paper Series with number 07-02.

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    Length: 20 pages
    Date of creation: Apr 2007
    Date of revision:
    Handle: RePEc:kud:epruwp:07-02

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    Keywords: capital controls; foreign shocks;

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