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Capital controls or macroprudential regulation?

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  • Korinek, Anton
  • Sandri, Damiano

Abstract

International capital flows can create significant financial instability in emerging economies. Does this make it optimal to impose capital controls or should policymakers rely on domestic macroprudential regulation in their quest for greater financial stability? This paper shows that it is desirable to employ both instruments to mitigate contractionary exchange rate depreciations: Macroprudential regulation reduces the amount and riskiness of financial liabilities, no matter whether they are financed by domestic or foreign lenders; capital controls increase the aggregate net worth of the economy by reducing net inflows. Both types of policy measures make the economy more stable and reduce the incidence and severity of crises. They should be set higher the greater an economy's debt burden and the higher domestic inequality. In a calibration based on the East Asian crisis countries, we find that it is optimal to impose both capital controls and macroprudential regulation that amount to a 2% tax on debt flows or equivalent quantity regulations. In advanced countries where the risk of contractionary exchange rate depreciations is more limited, the role for capital controls subsides. However, macroprudential regulation remains essential to mitigate booms and busts in asset prices.

Suggested Citation

  • Korinek, Anton & Sandri, Damiano, 2016. "Capital controls or macroprudential regulation?," Journal of International Economics, Elsevier, vol. 99(S1), pages 27-42.
  • Handle: RePEc:eee:inecon:v:99:y:2016:i:s1:p:s27-s42
    DOI: 10.1016/j.jinteco.2016.02.001
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    More about this item

    Keywords

    Capital flows; Financial stability; Pecuniary externalities; Capital controls; Macroprudential regulation; Inequality;

    JEL classification:

    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • 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

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