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Capital controls in China: A necessity for macroeconomic stability

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  • Zhou, Cheng

Abstract

This paper investigates the crucial role of capital controls in maintaining macroeconomic stability in China. We develop an open macroeconomic model integrating capital controls within a managed floating exchange rate system. Our model shows that capital controls enhance the effectiveness of foreign exchange interventions by restricting capital outflows and providing a broader array of policy options, though they may also create discrepancies between domestic and foreign asset holdings. Simulations using quarterly time-series data reveal that capital controls are essential for the success of both sterilized and non-sterilized interventions. These results indicate that the combined use of capital controls and foreign exchange interventions can reduce macroeconomic volatility in China. Moreover, our analysis of fixed versus floating exchange rate regimes suggests that an inappropriate regime choice can increase volatility in capital flows. Therefore, China should adopt a balanced financial approach within its managed floating system to stabilize the macroeconomy.

Suggested Citation

  • Zhou, Cheng, 2024. "Capital controls in China: A necessity for macroeconomic stability," Journal of Financial Stability, Elsevier, vol. 75(C).
    • Handle: RePEc:eee:finsta:v:75:y:2024:i:c:s1572308924001207
    DOI: 10.1016/j.jfs.2024.101335
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    More about this item

    Keywords

    Capital controls; Foreign exchange interventions; Economic fluctuation; Exchange rate regime; China;
    All these keywords.

    JEL classification:

    • F37 - International Economics - - International Finance - - - International Finance Forecasting and Simulation: Models and Applications
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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