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Dilemma Not Trilemma? Capital Controls and Exchange Rates with Volatile Capital Flows

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  • Emmanuel Farhi
  • Iván Werning

Abstract

The paper considers a standard New Keynesian model of a small open economy with nominal rigidities and studies optimal capital controls. Consistent with the Mundellian view, it finds that the exchange rate regime is key. However, in contrast with the Mundellian view, the paper finds that capital controls are desirable even when the exchange rate is flexible. Optimal capital controls lean against the wind and help smooth out capital flows.

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  • Emmanuel Farhi & Iván Werning, 2014. "Dilemma Not Trilemma? Capital Controls and Exchange Rates with Volatile Capital Flows," IMF Economic Review, Palgrave Macmillan;International Monetary Fund, vol. 62(4), pages 569-605, November.
  • Handle: RePEc:pal:imfecr:v:62:y:2014:i:4:p:569-605
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