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Capital Flows and Monetary Policy

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  • Javier Guillermo Gómez

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Abstract

Capital flows often confront central banks with a dilemma: to contain the exchange rate or to allow it to float. To tackle this problem, an equilibrium model of capital flows is proposed. The model captures sudden stops with shocks to the country risk premium. This enables the model to deal with capital outflows as well as capital inflows. From the equilibrium conditions of the model, I derive an expression for the accounting of net foreign assets, which helps study the evolution of foreign debt under different policy experiments. The policy experiments point to three main conclusions. First, interest rate defenses of the exchange rate can deliver recessions during capital outflows even in financially resilient economies. Second, during unanticipated reversals in capital inflows, the behavior of foreign debt is not necessarily improved by containing the exchange rate. Third, an economy can gain resilience not by simply shifting the currency denomination of debt, but by both, shifting the denomination and floating the currency.

Suggested Citation

  • Javier Guillermo Gómez, 2006. "Capital Flows and Monetary Policy," BORRADORES DE ECONOMIA 002097, BANCO DE LA REPÚBLICA.
  • Handle: RePEc:col:000094:002097
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    References listed on IDEAS

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    Cited by:

    1. Javier Guillermo Gómez, 2006. "La Política Monetaria En Colombia," BORRADORES DE ECONOMIA 003054, BANCO DE LA REPÚBLICA.

    More about this item

    Keywords

    Sudden stops; Credit booms; Country risk; Fear of floating; Debt sustainability;

    JEL classification:

    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
    • H62 - Public Economics - - National Budget, Deficit, and Debt - - - Deficit; Surplus
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt

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