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Optimal capital controls and real exchange rate policies: A pecuniary externality perspective

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  • Benigno, Gianluca
  • Chen, Huigang
  • Otrok, Christopher
  • Rebucci, Alessandro
  • Young, Eric R.

Abstract

A new literature studies the use of capital controls to prevent financial crises. Within this new framework, we show that when exchange rate policy is costless, there is no need for capital controls. However, if exchange rate policy entails efficiency costs, capital controls become part of the optimal policy mix. When exchange rate policy is costly, the optimal mix combines prudential capital controls in tranquil times with policies that limit exchange rate depreciation in crisis times. The optimal mix yields more borrowing, fewer and less severe financial crises, and much higher welfare than with capital controls alone.

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  • Benigno, Gianluca & Chen, Huigang & Otrok, Christopher & Rebucci, Alessandro & Young, Eric R., 2016. "Optimal capital controls and real exchange rate policies: A pecuniary externality perspective," Journal of Monetary Economics, Elsevier, vol. 84(C), pages 147-165.
  • Handle: RePEc:eee:moneco:v:84:y:2016:i:c:p:147-165
    DOI: 10.1016/j.jmoneco.2016.10.004
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    More about this item

    Keywords

    Capital controls; Exchange rate policy; Financial frictions; Financial crises; Financial stability; Optimal taxation; Macro-prudential policies;

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • 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

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