Capital Controls and Income Inequality

Zheng Liu, Mark Spiegel and Jingyi Zhang

No 2020-14, Working Paper Series from Federal Reserve Bank of San Francisco

Abstract: We examine the distributional implications of capital account policy in a small open economy model with heterogeneous agents and financial frictions. Households save through deposits in both domestic and foreign banks. Entrepreneurs finance investment with borrowed funds from domestic banks and foreign investors. Domestic banks engage in costly intermediation of deposits from households and loans to entrepreneurs. Government capital account policy consists of taxes on outflows and inflows. Given policy, a temporary decline in the world interest rate leads to a surge in inflows, benefiting entrepreneurs and hurting households. Raising inflow taxes or reducing outflow taxes mitigate this redistribution. However, in the long run liberalization of either inflows or outflows reduces inequality. The model’s short-run implications are supported by empirical evidence. Based on instrumental variable estimation with a panel of emerging market economies, we demonstrate that increases in private capital inflows raise income inequality, while increases in outflows reduce it. These effects are significant and robust to a wide variety of empirical specifications.

Keywords: Capital flows; income distribution; heterogeneous agents; financial frictions; small open economy (search for similar items in EconPapers)
JEL-codes: D63 F32 F38 (search for similar items in EconPapers)
Pages: 51
Date: 2020-04-14
New Economics Papers: this item is included in nep-fdg, nep-mon and nep-opm
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DOI: 10.24148/wp2020-14

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