How do Capital Controls Affect the Transmission of Foreign Shocks?

Dudley Cooke
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Dudley Cooke: University of Essex

No 07-02, EPRU Working Paper Series from Economic Policy Research Unit (EPRU), University of Copenhagen. Department of Economics

Abstract: This paper studies the short-run transmission of foreign shocks in a small open economy with capital controls and a fixed exchange rate. Capital controls alter the transmission of shocks because endogenous changes in the domestic nominal interest rate affect savings and investment decisions. The economy's reaction to export shocks hinges on how the government chooses to restrict capital flows; that is, whether inflows or outflows are restricted. For foreign interest rate shocks, private capital flows are important, but so are the government's holdings of foreign exchange reserves. Finally, a simple graphical apparatus is developed to provide a contrast to the case when capital flows are unrestricted.

Keywords: capital controls; foreign shocks (search for similar items in EconPapers)
JEL-codes: E58 F32 F41 (search for similar items in EconPapers)
Pages: 20 pages
Date: 2007-04
New Economics Papers: this item is included in nep-cba, nep-dge, nep-ifn, nep-mac and nep-mon
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