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On the Timing and Optimality of Capital Controls: Public Expenditures, Debt Dynamics and Welfare

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  • Raouf Boucekkine
  • Aude Pommeret
  • Fabien Prieur

Abstract

This paper solves a second-best problem where a government has in particular to choose whether to tax financial inflows (capital con- trols) or not, and when. A multi-stage optimal control technique is used to this end. First, it is shown that it is optimal to switch in finite time from capital controls to full financial liberalization (zero tax on capital inflows) whenever a measure of total wealth is above a cer- tain threshold. In particular, a too large initial debt makes financial liberalization sub-optimal. Second, our analysis suggests that capital controls should be used countercyclically: booms should be responded by more financial liberalization while recessions should rather lead to more stringent capital controls. Third, when public expenditure is chosen in order to maximize social welfare, financial liberalization is not unaffordable only for poor countries, even wealthy countries might find it optimal to implement capital controls if they aim to keep a large amount of public expenditure. In short, the preservation of the welfare states might require a more frequent use of capital controls.

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File URL: http://www.lameta.univ-montp1.fr/Documents/DR2012-15.pdf
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Bibliographic Info

Paper provided by LAMETA, Universtiy of Montpellier in its series Working Papers with number 12-15.

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Length: 16 pages
Date of creation: May 2012
Date of revision: May 2012
Handle: RePEc:lam:wpaper:12-15

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  1. Acemoglu, Daron & Zilibotti, Fabrizio, 1996. "Was Prometheus Unbound by Chance? Risk, Diversification and Growth," CEPR Discussion Papers 1426, C.E.P.R. Discussion Papers.
  2. Kose, M. Ayhan & Prasad, Eswar S. & Taylor, Ashley D., 2009. "Thresholds in the process of international financial integration," Policy Research Working Paper Series 5149, The World Bank.
  3. Tomiyama, Ken, 1985. "Two-stage optimal control problems and optimality conditions," Journal of Economic Dynamics and Control, Elsevier, vol. 9(3), pages 317-337, November.
  4. Makris, Miltiadis, 2001. "Necessary conditions for infinite-horizon discounted two-stage optimal control problems," Journal of Economic Dynamics and Control, Elsevier, vol. 25(12), pages 1935-1950, December.
  5. Olivier Jeanne & Anton Korinek, 2010. "Excessive Volatility in Capital Flows: A Pigouvian Taxation Approach," NBER Working Papers 15927, National Bureau of Economic Research, Inc.
  6. BOUCEKKINE, RAOUF & SAGLAM , Cagri & VALLÉE, Thomas, 2003. "Technology adoption under embodiment: a two-stage optimal control approach," CORE Discussion Papers 2003055, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
  7. repec:cor:louvrp:2335 is not listed on IDEAS
  8. Kevin Gallagher, 2012. "The Myth of Financial Protectionism: The New (and old) Economics of Capital Controls," Working Papers wp278, Political Economy Research Institute, University of Massachusetts at Amherst.
  9. Joshua Aizenman & Michael M. Hutchison & Yothin Jinjarak, 2011. "What is the Risk of European Sovereign Debt Defaults? Fiscal Space, CDS Spreads and Market Pricing of Risk," NBER Working Papers 17407, National Bureau of Economic Research, Inc.
  10. Anton Korinek, 2011. "The New Economics of Capital Controls Imposed for Prudential Reasons+L4888," IMF Working Papers 11/298, International Monetary Fund.
  11. Raouf Boucekkine & Giorgio Fabbri & Patrick A. Pintus, 2013. "Short-Run Pain, Long-Run Gain: The Conditional Welfare Gains from International Financial Integration," Working Papers halshs-00790569, HAL.
  12. Raouf Boucekkine & Giorgio Fabbri & Patrick Pintus, 2012. "Short-Run Pain, Long-Run Gain: The Conditional Welfare Gains from International Financial Integration The Conditional Welfare Gains from International Financial Integration," AMSE Working Papers 1202, Aix-Marseille School of Economics, Marseille, France, revised 12 Feb 2012.
  13. BOUCEKKINE, Raouf & KRAWCZYK, Jacek B. & VALLEE, Thomas, . "Environmental quality versus economic performance: a dynamic game approach," CORE Discussion Papers RP -2335, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
  14. Raouf Boucekkine & Patrick Pintus, 2012. "History’s a curse: leapfrogging, growth breaks and growth reversals under international borrowing without commitment," Journal of Economic Growth, Springer, vol. 17(1), pages 27-47, March.
  15. Raouf Boucekkine & Giorgio Fabbri & Patrick-Antoine Pintus, 2011. "Leapfrogging, Growth Reversals and Welfare," Working Papers halshs-00576743, HAL.
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Cited by:
  1. Daria Onori, 2013. "Optimal Growth under Flow-Based Collaterals," Working Papers halshs-00824672, HAL.

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