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Optimal Capital Controls and Real Exchange Rate Policies: A Pecuniary Externality Perspective

Author

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

Abstract

A new theoretical literature studies the use of capital controls to prevent financial crises in models in which pecuniary externalities justify government intervention. Within the same theoretical framework, we show that when ex-post policies such as defending the exchange rate can contain or resolve financial crises, there is no need to intervene ex-ante with capital controls. On the other hand, if crises management policies entail some efficiency costs, then crises prevention policies become part of the optimal policy mix. In the standard model economy used in the literature with costly crisis management policies, the optimal policy mix combines capital controls in tranquil times with support for the real exchange rate to limit its depreciation during crises times. The optimal policy mix yields more borrowing and consumption, a lower probability of financial crisis, and twice as large welfare gains than in the socially planned equilibrium with capital controls alone.

Suggested Citation

  • Gianluca Benigno & Huigang Chen & Christopher Otrok & Alessandro Rebucci & Eric R. Young, 2016. "Optimal Capital Controls and Real Exchange Rate Policies: A Pecuniary Externality Perspective," NBER Working Papers 22224, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:22224 Note: EFG IFM ME
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    Cited by:

    1. Alfaro, Laura & Cunat, Alejandro & Fadinger, Harald & Yanping, Liu, 2017. "The real exchange rate, innovation and productivity," Working Papers 17-04, University of Mannheim, Department of Economics.
    2. Choi, Woo Jin & Taylor, Alan M., 2017. "Precaution Versus Mercantilism: Reserve Accumulation, Capital Controls, and the Real Exchange Rate," CEPR Discussion Papers 11963, C.E.P.R. Discussion Papers.
    3. Julian A. Parra-Polania & Carmiña O. Vargas, 2016. "Relevance of the fiscal-policy setup in the analysis of macroprudential and ex-post financial crisis interventions," Borradores de Economia 945, Banco de la Republica de Colombia.
    4. Markus K. Brunnermeier & Yuliy Sannikov, 2015. "International Credit Flows and Pecuniary Externalities," American Economic Journal: Macroeconomics, American Economic Association, vol. 7(1), pages 297-338, January.
    5. Carmiña O. Vargas & Julian A. Parra-Polania, 2017. "Optimal crisis interventions in an open economy with credit constraint," Borradores de Economia 989, Banco de la Republica de Colombia.
    6. Engel, Charles, 2016. "Macroprudential policy under high capital mobility: policy implications from an academic perspective," Journal of the Japanese and International Economies, Elsevier, pages 162-172.
    7. Julian A. Parra-Polania & Carmiña O. Vargas, 2015. "Macroprudential vs. Ex-post Policy Interventions: when Domestic Taxes are Relevant for International Lenders," Borradores de Economia 879, Banco de la Republica de Colombia.
    8. Giancarlo Corsetti & Keith Kuester & Gernot J. Müller, 2017. "Fixed on Flexible: Rethinking Exchange Rate Regimes after the Great Recession," IMF Economic Review, Palgrave Macmillan;International Monetary Fund, vol. 65(3), pages 586-632, August.
    9. repec:bdr:ensayo:v:35:y:2017:i:82:p:2-9 is not listed on IDEAS
    10. Valerio Nispi Landi, 2107. "Capital controls, macroprudential measures and monetary policy interactions in an emerging economy," Temi di discussione (Economic working papers) 1154, Bank of Italy, Economic Research and International Relations Area.
    11. repec:spr:joecth:v:63:y:2017:i:4:d:10.1007_s00199-016-0975-2 is not listed on IDEAS
    12. Corsetti, Giancarlo & Kuester, Keith & Müller, Gernot J., 2017. "Fixed on flexible rethink exchange rate regimes after the Great Recession," LSE Research Online Documents on Economics 86154, London School of Economics and Political Science, LSE Library.
    13. Schmitt-Grohé, Stephanie & Uribe, Martin, 2016. "Is Optimal Capital-Control Policy Countercyclical In Open-Economy Models With Collateral Constraints?," CEPR Discussion Papers 11619, C.E.P.R. Discussion Papers.
    14. repec:pal:imfecr:v:65:y:2017:i:3:d:10.1057_s41308-017-0032-6 is not listed on IDEAS
    15. Charles Engel, 2015. "Macroprudential Policy in a World of High Capital Mobility: Policy Implications from an Academic Perspective," NBER Working Papers 20951, National Bureau of Economic Research, Inc.
    16. Juan M. Hernandez & Enrique G. Mendoza, 2017. "Optimal v. simple financial policy rules in a production economy with “liability dollarization," Ensayos sobre Política Económica, Banco de la Republica de Colombia, vol. 35(82), pages 1-15, April.
    17. repec:eee:inecon:v:109:y:2017:i:c:p:43-67 is not listed on IDEAS
    18. Anton Korinek, 2017. "Regulating Capital Flows to Emerging Markets: An Externality View," NBER Working Papers 24152, National Bureau of Economic Research, Inc.
    19. Mitsuru Katagiri & Ryo Kato & Takayuki Tsuruga, 2017. "Prudential capital controls or bailouts? The impact of different collateral constraint assumptions," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 63(4), pages 943-960, April.
    20. Nadav Ben Zeev, 2017. "Exchange Rate Regimes And Sudden Stops," Working Papers 1712, Ben-Gurion University of the Negev, Department of Economics.
    21. Stephanie Schmitt-Grohé & Martín Uribe, 2017. "Adjustment to small, large, and sunspot shocks in open economies with stock collateral constraints," Ensayos sobre Política Económica, Banco de la Republica de Colombia, vol. 35(82), pages 2-9, April.

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    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • F38 - International Economics - - International Finance - - - International Financial Policy: Financial Transactions Tax; Capital Controls
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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