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Capital controls and monetary policy in sudden-stop economies

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  • Devereux, Michael B.
  • Young, Eric R.
  • Yu, Changhua

Abstract

The dangers of high capital flow volatility and sudden stops have led economists to promote the use of capital controls as an addition to monetary policy in emerging market economies. This paper studies the benefits of capital controls and monetary policy in a small open economy with financial frictions, nominal rigidities, and sudden stops. Without commitment, the optimal monetary policy should sharply diverge from price stability. The policymakers will also tax capital inflows in a crisis, but such taxes may be welfare reducing. With commitment, capital controls involve a mix of current capital inflow taxes and future capital flow subsidies. The optimal policy will never involve macro-prudential capital inflow taxes or a departure from price stability, whether or not commitment is available.

Suggested Citation

  • Devereux, Michael B. & Young, Eric R. & Yu, Changhua, 2019. "Capital controls and monetary policy in sudden-stop economies," Journal of Monetary Economics, Elsevier, vol. 103(C), pages 52-74.
  • Handle: RePEc:eee:moneco:v:103:y:2019:i:c:p:52-74
    DOI: 10.1016/j.jmoneco.2018.07.016
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    3. J. Scott Davis & Michael B. Devereux & Changhua Yu, 2020. "Sudden Stops in Emerging Economies: The Role of World Interest Rates and Foreign Exchange Intervention," Globalization Institute Working Papers 405, Federal Reserve Bank of Dallas, revised 10 Sep 2021.
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    8. Chokri Zehri, 2020. "The Domestic Impacts And Spillovers Of Capital Controls," Economic Annals, Faculty of Economics, University of Belgrade, vol. 65(227), pages 31-66, October –.
    9. Paolo Cavallino & Boris Hofmann, 2022. "Capital flows and monetary policy trade-offs in emerging market economies," BIS Working Papers 1032, Bank for International Settlements.
    10. Louphou COULIBALY, 2018. "Monetary Policy in Sudden Stop-Prone Economies," Cahiers de recherche 06-2018, Centre interuniversitaire de recherche en économie quantitative, CIREQ.
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    12. Daniel Murphy & Eric R. Young, 2020. "Government Debt Limits and Stabilization Policy," Working Papers 20-23, Federal Reserve Bank of Cleveland.
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