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How do Capital Controls Affect the Transmission of Foreign Shocks?

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  • Dudley Cooke

    (University of Essex)

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.

Suggested Citation

  • Dudley Cooke, 2007. "How do Capital Controls Affect the Transmission of Foreign Shocks?," EPRU Working Paper Series 07-02, Economic Policy Research Unit (EPRU), University of Copenhagen. Department of Economics.
    • Handle: RePEc:kud:epruwp:07-02
    as

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    File URL: http://web.econ.ku.dk/eprn_epru/Workings_Papers/wp-07-02.pdf
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    References listed on IDEAS

    as
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    More about this item

    Keywords

    capital controls; foreign shocks;

    JEL classification:

    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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