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Monetary Policy, Capital Controls, and International Portfolios

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Abstract

I study optimal monetary policy and capital controls in an open economy New Keynesian model with endogenous portfolio choice. I develop an approximation method to characterize the solution sharply. The optimal policy balances two goals: (i) stabilizing output and inflation and (ii) enhancing the insurance properties of home-currency assets. The relative importance of these goals depends on the international portfolio. When the portfolio is optimally chosen, its exposure to home-currency fluctuations increases as the need for insurance grows, further amplifying the weight on insurance. This effect is significant. In a calibrated model for Canada, if the portfolio were held at its calibrated value rather than optimally chosen, the weight on insurance would be about five times smaller. Despite aggregate-demand externalities and incomplete markets, implementing the optimal portfolio does not require differential capital controls across asset classes.

Suggested Citation

  • Sebastián Fanelli, 2026. "Monetary Policy, Capital Controls, and International Portfolios," Working Papers wp2026_2608, CEMFI.
    • Handle: RePEc:cmf:wpaper:wp2026_2608
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    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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