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Capital controls as an instrument of monetary policy

  • Davis, Scott

    ()

    (Federal Reserve Bank of Dallas)

  • Presno, Ignacio

    ()

    (Federal Reserve Bank of Boston)

Large swings in capital flows into and out of emerging markets can potentially lead to excessive volatility in asset prices and credit supply. In order to lessen the impact of capital flows on financial instability, a number of researchers and policy markers have recently proposed the use of capital controls. This paper considers the benefit of adding capital controls as a potential instrument of monetary policy in a small open economy. In a DSGE framework, we find that when domestic agents are subject to collateral constraints and the value of collateral is subject to fluctuations driven by foreign capital inflows and outflows, the adoption of temporary capital controls can lead to a significant welfare improvement. The benefits of capital controls are present even when monetary policy is determined optimally, implying that there may be a role for capital controls to exist side-by-side with conventional monetary tools as an instrument of monetary policy.

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Paper provided by Federal Reserve Bank of Dallas in its series Globalization and Monetary Policy Institute Working Paper with number 171.

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Length: 36 pages
Date of creation: 01 Feb 2014
Date of revision:
Handle: RePEc:fip:feddgw:171
Contact details of provider: Web page: http://www.dallasfed.org/
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