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Capital Controls and Foreign Currency Denomination

Author

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  • Guangling Liu

    (University of Stellenbosch)

  • Fernando Garcia-Barragan

Abstract

This paper studies the effectiveness of capital controls with foreign currency denomination on business cycle fluctuations and the implications for welfare. To do this, we develop a general equilibrium model with financial frictions and banking, in which assets and liabilities are denominated in both domestic and foreign currencies. We propose a non-pecuniary, capital-control policy that limits the gap between foreign-currency denominated loans and deposits to the amount of foreign funds that bankers can borrow from the international credit market. We show that capital controls have a significant impact on the dynamics of assets and liabilities that are denominated in foreign currency. The non-pecuniary capital controls help to stabilize the financial sector, thereby reducing the negative spillovers to the real economy. A more restrictive capital-control policy significantly weakens the welfare effect of the foreign monetary policy and exchange rate shocks.

Suggested Citation

  • Guangling Liu & Fernando Garcia-Barragan, 2017. "Capital Controls and Foreign Currency Denomination," 2017 Meeting Papers 415, Society for Economic Dynamics.
  • Handle: RePEc:red:sed017:415
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    References listed on IDEAS

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    More about this item

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • 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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