Government Revenue from Capital Controls: With Focus on Interest Seigniorage

One of the practical roles of capital controls is to help governments keep the level of domestic interest rates lower than the world interest rate, which would not be possible at all unless the domestic ï¬ nancial market is separated from the global market. The resulting saving in debt service is regarded as an additional source of government revenue and is accordingly called government revenue from capital controls. Using a ï¬ nite time horizon model with dynamically optimizing consumers, this paper shows that it is possible for governments to lower domestic interest rates by imposing capital controls alone and thereby to reduce the burden of debt service. It is also demonstrated that the level of domestic interest rate and the amount of savings in debt service depend on the amount of foreign bonds held by the public at the time of controls. The smaller is the amount of foreign bond holdings, the lower is the steady state domestic interest rate and the larger is the reduction in debt service.