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Dilemma not Trilemma? Capital Controls and Exchange Rates with Volatile Capital Flows

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  • Emmanuel Farhi
  • Ivan Werning

Abstract

We consider a standard New Keynesian model of a small open economy with nominal rigidities and study optimal capital controls. Consistent with the Mundellian view, we find that the exchange rate regime is key. However, in contrast with the Mundellian view, we find that capital controls are desirable even when the exchange rate is flexible. Optimal capital controls lean against the wind and help smooth out capital flows.

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  • Emmanuel Farhi & Ivan Werning, "undated". "Dilemma not Trilemma? Capital Controls and Exchange Rates with Volatile Capital Flows," Working Paper 133566, Harvard University OpenScholar.
    • Handle: RePEc:qsh:wpaper:133566
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    File URL: http://scholar.harvard.edu/farhi/node/133566
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