IDEAS home Printed from https://ideas.repec.org/a/eee/inecon/v151y2024ics0022199624000928.html

Capital controls and trade policy

Author

Listed:
  • Lloyd, Simon P.
  • Marin, Emile A.

Abstract

How does optimal capital-flow management change with prevailing trade policies? We study the joint optimal determination of capital controls and trade tariffs in a two-country, two-good model with trade in goods and assets. Because countries are large in both markets, a country-planner can achieve higher domestic welfare by departing from free trade in addition to levying capital controls, despite the cooperative optimal allocation being efficient. However, time variation in the optimal tariff induces households to over- or under-borrow through its effects on the path of the real exchange rate. As a result, optimal capital controls are generally smaller when trade policy is constrained (i.e., by a Free-Trade Agreement), but, absent retaliation, can be larger depending on the paths of underlying fundamentals.

Suggested Citation

  • Lloyd, Simon P. & Marin, Emile A., 2024. "Capital controls and trade policy," Journal of International Economics, Elsevier, vol. 151(C).
    • Handle: RePEc:eee:inecon:v:151:y:2024:i:c:s0022199624000928
    DOI: 10.1016/j.jinteco.2024.103965
    as

    Download full text from publisher

    File URL: http://www.sciencedirect.com/science/article/pii/S0022199624000928
    Download Restriction: Full text for ScienceDirect subscribers only
    File URL: https://libkey.io/10.1016/j.jinteco.2024.103965?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    As the access to this document is restricted, you may want to look for a different version below or

    for a different version of it.

    Other versions of this item:

    References listed on IDEAS

    as
    1. Emmanuel Farhi & Iván Werning, 2014. "Dilemma Not Trilemma? Capital Controls and Exchange Rates with Volatile Capital Flows," IMF Economic Review, Palgrave Macmillan;International Monetary Fund, vol. 62(4), pages 569-605, November.
    2. Stephanie Schmitt-Grohé & Martín Uribe, 2016. "Downward Nominal Wage Rigidity, Currency Pegs, and Involuntary Unemployment," Journal of Political Economy, University of Chicago Press, vol. 124(5), pages 1466-1514.
    3. Atish R. Ghosh & Jonathan D. Ostry & Mahvash S. Qureshi, 2016. "When Do Capital Inflow Surges End in Tears?," American Economic Review, American Economic Association, vol. 106(5), pages 581-585, May.
    4. Jan De Loecker & Pinelopi K. Goldberg & Amit K. Khandelwal & Nina Pavcnik, 2016. "Prices, Markups, and Trade Reform," Econometrica, Econometric Society, vol. 84, pages 445-510, March.
    5. Olivier Jeanne, 2013. "Capital Account Policies and the Real Exchange Rate," NBER International Seminar on Macroeconomics, University of Chicago Press, vol. 9(1), pages 7-42.
    6. Taylor, Alan M. & Caliendo, Lorenzo & Feenstra, Robert & Romalis, John, 2021. "A Second-best Argument for Low Optimal Tariffs," CEPR Discussion Papers 15697, C.E.P.R. Discussion Papers.
    7. Corsetti, Giancarlo & Dedola, Luca & Leduc, Sylvain, 2023. "Exchange rate misalignment and external imbalances: What is the optimal monetary policy response?," Journal of International Economics, Elsevier, vol. 144(C).
    8. Javier Bianchi, 2011. "Overborrowing and Systemic Externalities in the Business Cycle," American Economic Review, American Economic Association, vol. 101(7), pages 3400-3426, December.
    9. Bank for International Settlements, 2008. "Financial globalisation and emerging market capital flows," BIS Papers, Bank for International Settlements, number 44, May.
    10. Cole, Harold L. & Obstfeld, Maurice, 1991. "Commodity trade and international risk sharing : How much do financial markets matter?," Journal of Monetary Economics, Elsevier, vol. 28(1), pages 3-24, August.
    11. James W. Friedman, 1973. "A Non-cooperative Equilibrium for Supergames: A Correction," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 40(3), pages 435-435.
    12. Hites Ahir & Nicholas Bloom & Davide Furceri, 2022. "The world uncertainty index," CEP Discussion Papers dp1842, Centre for Economic Performance, LSE.
    13. Maurice Obstfeld & Kenneth S. Rogoff, 1996. "Foundations of International Macroeconomics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262150476, December.
    14. Arnaud Costinot & Guido Lorenzoni & Iván Werning, 2014. "A Theory of Capital Controls as Dynamic Terms-of-Trade Manipulation," Journal of Political Economy, University of Chicago Press, vol. 122(1), pages 77-128.
    15. Sebastián Fanelli & Ludwig Straub, 2021. "A Theory of Foreign Exchange Interventions [The Cost of Foreign Exchange Intervention: Concepts and Measurement]," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 88(6), pages 2857-2885.
    16. Jeanne, Olivier, 2021. "Currency Wars, Trade Wars and Global Demand," Economics Working Paper Archive 66667, The Johns Hopkins University,Department of Economics.
    17. Backus, David K. & Smith, Gregor W., 1993. "Consumption and real exchange rates in dynamic economies with non-traded goods," Journal of International Economics, Elsevier, vol. 35(3-4), pages 297-316, November.
    18. Drew Fudenberg & David K. Levine, 2008. "Open-Loop and Closed-Loop Equilibria in Dynamic Games with Many Players," World Scientific Book Chapters, in: Drew Fudenberg & David K Levine (ed.), A Long-Run Collaboration On Long-Run Games, chapter 3, pages 41-58, World Scientific Publishing Co. Pte. Ltd..
    19. Demidova, Svetlana & Rodríguez-Clare, Andrés, 2009. "Trade policy under firm-level heterogeneity in a small economy," Journal of International Economics, Elsevier, vol. 78(1), pages 100-112, June.
    20. Emmanuel Farhi & Iván Werning, 2016. "A Theory of Macroprudential Policies in the Presence of Nominal Rigidities," Econometrica, Econometric Society, vol. 84, pages 1645-1704, September.
    21. Lucas, Robert Jr. & Stokey, Nancy L., 1983. "Optimal fiscal and monetary policy in an economy without capital," Journal of Monetary Economics, Elsevier, vol. 12(1), pages 55-93.
    22. Drew Fudenberg & David K. Levine, 1988. "Open and Closed-Loop Equilibria in Dynamic Games With Many Players," Levine's Working Paper Archive 221, David K. Levine.
    23. Bergin, Paul R. & Corsetti, Giancarlo, 2023. "The macroeconomic stabilization of tariff shocks: What is the optimal monetary response?," Journal of International Economics, Elsevier, vol. 143(C).
    24. Chari, V.V. & Kehoe, Patrick J., 1999. "Optimal fiscal and monetary policy," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 26, pages 1671-1745, Elsevier.
    25. Stéphane Auray & Devereux Michael B. & Aurélien Eyquem, 2020. "Trade Wars, Currency Wars," Post-Print halshs-03031865, HAL.
    26. Jiandong Ju & Kang Shi & Shang-Jin Wei, 2013. "On the Connections between Intra-temporal and Intertemporal Trades," NBER Chapters, in: NBER International Seminar on Macroeconomics 2013, pages 36-51, National Bureau of Economic Research, Inc.
    27. Kollmann, Robert, 1995. "Consumption, real exchange rates and the structure of international asset markets," Journal of International Money and Finance, Elsevier, vol. 14(2), pages 191-211, April.
    28. Barry Eichengreen, 2019. "Trade Policy and the Macroeconomy," IMF Economic Review, Palgrave Macmillan;International Monetary Fund, vol. 67(1), pages 4-23, March.
    29. Emmanuel Farhi & Gita Gopinath & Oleg Itskhoki, 2014. "Fiscal Devaluations," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 81(2), pages 725-760.
    30. Baier, Scott L. & Bergstrand, Jeffrey H., 2007. "Do free trade agreements actually increase members' international trade?," Journal of International Economics, Elsevier, vol. 71(1), pages 72-95, March.
    31. Enrique G. Mendoza, 2002. "Credit, Prices, and Crashes: Business Cycles with a Sudden Stop," NBER Chapters, in: Preventing Currency Crises in Emerging Markets, pages 335-392, National Bureau of Economic Research, Inc.
    32. Xavier Gabaix & Matteo Maggiori, 2015. "International Liquidity and Exchange Rate Dynamics," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 130(3), pages 1369-1420.
    33. Geanakoplos, J. & Polemarchakis, H., 1985. "Existence,regularity, and constrained suboptimality of competitive allocations when the asset market is incomplete," LIDAM Discussion Papers CORE 1985037, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
    34. Christian Broda & Nuno Limão & David E. Weinstein, 2018. "Optimal Tariffs and Market Power: The Evidence," World Scientific Book Chapters, in: Policy Externalities and International Trade Agreements, chapter 2, pages 13-46, World Scientific Publishing Co. Pte. Ltd..
    35. Andrés Fernández & Michael W Klein & Alessandro Rebucci & Martin Schindler & Martín Uribe, 2016. "Capital Control Measures: A New Dataset," IMF Economic Review, Palgrave Macmillan;International Monetary Fund, vol. 64(3), pages 548-574, August.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Geyue Sun & Xiao Liu & Tomas Williams & Roberto Samaniego, 2025. "Learning to Regulate: A New Event-Level Dataset of Capital Control Measures," Papers 2505.23025, arXiv.org.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Simon P. Lloyd & Emile A. Marin, 2023. "Capital Controls and Free-Trade Agreements," Discussion Papers 2306, Centre for Macroeconomics (CFM).
    2. Norring, Anni, 2022. "Taming the tides of capital: Review of capital controls and macroprudential policy in emerging economies," BoF Economics Review 1/2022, Bank of Finland.
    3. Acharya, Sushant & Bengui, Julien, 2018. "Liquidity traps, capital flows," Journal of International Economics, Elsevier, vol. 114(C), pages 276-298.
    4. Javier Bianchi & Guido Lorenzoni, 2021. "The Prudential Use of Capital Controls and Foreign Currency Reserves," NBER Working Papers 29476, National Bureau of Economic Research, Inc.
    5. Corsetti, Giancarlo & Dedola, Luca & Leduc, Sylvain, 2023. "Exchange rate misalignment and external imbalances: What is the optimal monetary policy response?," Journal of International Economics, Elsevier, vol. 144(C).
    6. Pierre Olivier Gourinchas, 2023. "International Macroeconomics: From the Great Financial Crisis to COVID-19, and Beyond," IMF Economic Review, Palgrave Macmillan;International Monetary Fund, vol. 71(1), pages 1-34, March.
    7. Lovchikova, Marina & Matschke, Johannes, 2024. "Capital controls and the global financial cycle," European Economic Review, Elsevier, vol. 163(C).
    8. Alessandro Rebucci & Chang Ma, 2019. "Capital Controls: A Survey of the New Literature," NBER Working Papers 26558, National Bureau of Economic Research, Inc.
    9. Bilge Erten & Anton Korinek & José Antonio Ocampo, 2021. "Capital Controls: Theory and Evidence," Journal of Economic Literature, American Economic Association, vol. 59(1), pages 45-89, March.
    10. Sebastián Fanelli & Ludwig Straub, 2021. "A Theory of Foreign Exchange Interventions [The Cost of Foreign Exchange Intervention: Concepts and Measurement]," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 88(6), pages 2857-2885.
    11. Stijn Claessens & M Ayhan Kose, 2018. "Frontiers of macrofinancial linkages," BIS Papers, Bank for International Settlements, number 95, May.
    12. Simon P. Lloyd & Emile A. Marin, 2023. "Capital Controls and Free-Trade Agreements," Discussion Papers 2306, Centre for Macroeconomics (CFM).
    13. Korinek, Anton, 2018. "Regulating capital flows to emerging markets: An externality view," Journal of International Economics, Elsevier, vol. 111(C), pages 61-80.
    14. Markus K. Brunnermeier & Yuliy Sannikov, 2015. "International Credit Flows and Pecuniary Externalities," American Economic Journal: Macroeconomics, American Economic Association, vol. 7(1), pages 297-338, January.
    15. Fontanier, Paul, 2025. "Optimal policy for behavioral financial crises," Journal of Financial Economics, Elsevier, vol. 166(C).
    16. Ottonello, Pablo, 2021. "Optimal exchange-rate policy under collateral constraints and wage rigidity," Journal of International Economics, Elsevier, vol. 131(C).
    17. Julien Bengui & Louphou Coulibaly, 2022. "Inflation and Capital Flows," NBER Working Papers 30652, National Bureau of Economic Research, Inc.
    18. Richa Jain & Amlendu Dubey, 2025. "Dynamic treatment effect of capital controls on macroeconomic and financial stability in emerging market economies," Empirical Economics, Springer, vol. 68(3), pages 963-999, March.
    19. Johannes Matschke, 2021. "International Financial Regulation: The Role of Banking Sector Sizes," Research Working Paper RWP 21-13, Federal Reserve Bank of Kansas City, revised 10 Jul 2024.
    20. Corsetti, Giancarlo & Dedola, Luca & Leduc, Sylvain, 2018. "Exchange Rate Misalignment, Capital Flows, and Optimal Monetary Policy Trade-offs," CEPR Discussion Papers 12850, C.E.P.R. Discussion Papers.

    More about this item

    Keywords

    ;
    ;
    ;
    ;
    ;

    JEL classification:

    • F13 - International Economics - - Trade - - - Trade Policy; International Trade Organizations
    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
    • F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions
    • F38 - International Economics - - International Finance - - - International Financial Policy: Financial Transactions Tax; Capital Controls

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:eee:inecon:v:151:y:2024:i:c:s0022199624000928. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Catherine Liu (email available below). General contact details of provider: http://www.elsevier.com/locate/inca/505552 .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.