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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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    Cited by:

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    2. Lee, David, 2023. "Modeling Collateralization and Its Economic Significance," MPRA Paper 118678, University Library of Munich, Germany.
    3. Liu, Zheng & Spiegel, Mark M. & Zhang, Jingyi, 2021. "Optimal capital account liberalization in China," Journal of Monetary Economics, Elsevier, vol. 117(C), pages 1041-1061.
    4. Christopher Otrok & Andrew Foerster & Alessandro Rebucci & Gianluca Benigno, 2017. "Estimating Macroeconomic Models of Financial Crises: An Endogenous Regime Switching Approach," 2017 Meeting Papers 572, Society for Economic Dynamics.
    5. Louphou Coulibaly, 2023. "Monetary Policy in Sudden Stop-Prone Economies," American Economic Journal: Macroeconomics, American Economic Association, vol. 15(4), pages 141-176, October.
    6. 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.
    7. Bengui, Julien & Bianchi, Javier, 2022. "Macroprudential policy with leakages," Journal of International Economics, Elsevier, vol. 139(C).
    8. Fan, Haichao & Gou, Qin & Peng, Yuchao & Xie, Wenjing, 2020. "Spillover effects of capital controls on capital flows and financial risk contagion," Journal of International Money and Finance, Elsevier, vol. 105(C).
    9. Chokri Zehri, 2022. "Interaction Effect of Capital Controls and Macroeconomic Policies," Economic Papers, The Economic Society of Australia, vol. 41(1), pages 15-33, March.
    10. Cristina Arellano & Yan Bai & Gabriel Mihalache, 2018. "Inflation Targeting with Sovereign Default Risk," Department of Economics Working Papers 18-14, Stony Brook University, Department of Economics.
    11. Chokri Zehri, 2020. "The Domestic Impacts And Spillovers Of Capital Controls," Economic Annals, Faculty of Economics and Business, University of Belgrade, vol. 65(227), pages 31-66, October –.
    12. Paolo Cavallino & Boris Hofmann, 2022. "Capital flows and monetary policy trade-offs in emerging market economies," BIS Working Papers 1032, Bank for International Settlements.
    13. Davis, J. Scott & Devereux, Michael B. & Yu, Changhua, 2023. "Sudden stops and optimal foreign exchange intervention," Journal of International Economics, Elsevier, vol. 141(C).
    14. Chokri Zehri & David McMillan, 2020. "Restrictive policy impacts in emerging economies," Cogent Economics & Finance, Taylor & Francis Journals, vol. 8(1), pages 1815979-181, January.
    15. Daniel Murphy & Eric Young, 2020. "Government Debt Limits and Stabilization Policy," Working Papers 20-23, Federal Reserve Bank of Cleveland.
    16. Cristina Arellano & Yan Bai & Gabriel Mihalache, 2019. "Monetary Policy and Sovereign Risk in Emerging Economies (NK-Default)," Department of Economics Working Papers 19-02-rev1, Stony Brook University, Department of Economics.

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