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Capital Controls or Real Exchange Rate Policy?: A Pecuniary Externality Perspective

  • Gianluca Benigno
  • Huigang Chen
  • Christopher Otrok
  • Alessandro Rebucci
  • Eric R. Young

In the aftermath of the global financial crisis, a new policy paradigm has emerged in which old-fashioned policies such as capital controls and other government distortions have become part of the standard policy tool kit (so called macro- prudential policies). On the wave of this seemingly unanimous policy consensus, a new strand of theoretical literature contends that capital controls are welfare enhancing and can be justified rigorously because of second-best considerations. Within the same theoretical framework adopted in this fast-growing literature, this paper shows that a credible commitment to support the exchange rate in crisis times always welfare-dominates prudential capital controls, as it can achieve unconstrained allocation.

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Paper provided by Inter-American Development Bank in its series IDB Publications (Working Papers) with number 80682.

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Date of creation: Mar 2013
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Handle: RePEc:idb:brikps:80682
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  1. Javier Bianchi, 2010. "Overborrowing and Systemic Externalities in the Business Cycle," 2010 Meeting Papers 96, Society for Economic Dynamics.
  2. Ricardo J Caballero, 2010. "Sudden Financial Arrest," IMF Economic Review, Palgrave Macmillan, vol. 58(1), pages 6-36, August.
  3. Bianca De Paoli & Anna Lipinska, 2013. "Capital controls: a normative analysis," Staff Reports 600, Federal Reserve Bank of New York.
  4. Gianluca Benigno & Luca Fornaro, 2013. "The financial resource curse," LSE Research Online Documents on Economics 51557, London School of Economics and Political Science, LSE Library.
  5. Anton Korinek, 2011. "The New Economics of Prudential Capital Controls: A Research Agenda," IMF Economic Review, Palgrave Macmillan, vol. 59(3), pages 523-561, August.
  6. Bruce Ian Carlin & Shaun William Davies & Andrew Miles Iannaccone, 2010. "Competing for Attention in Financial Markets," NBER Working Papers 16085, National Bureau of Economic Research, Inc.
  7. repec:ner:tilbur:urn:nbn:nl:ui:12-3107633 is not listed on IDEAS
  8. Paul Krugman, 1999. "Balance Sheets, the Transfer Problem, and Financial Crises," International Tax and Public Finance, Springer, vol. 6(4), pages 459-472, November.
  9. Enrique Mendoza & Javier Bianchi, 2010. "Overborrowing, financial crises and ‘macro-prudential’ taxes," Proceedings, Federal Reserve Bank of San Francisco, issue Oct.
  10. Jonathan David Ostry & Atish R. Ghosh & Anton Korinek, 2012. "Multilateral Aspects of Managing the Capital Account," IMF Staff Discussion Notes 12/10, International Monetary Fund.
  11. Timothy J Kehoe & David K Levine, 1993. "Debt Constrained Asset Markets," Levine's Working Paper Archive 1276, David K. Levine.
  12. Nicolas E. Magud & Carmen M. Reinhart & Kenneth S. Rogoff, 2011. "Capital Controls: Myth and Reality - A Portfolio Balance Approach," NBER Working Papers 16805, National Bureau of Economic Research, Inc.
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