Monetary Policy, Capital Controls, and International Portfolios

Sebastián Fanelli ()
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Sebastián Fanelli: CEMFI, Centro de Estudios Monetarios y Financieros, https://www.cemfi.es/

Working Papers from CEMFI

Abstract: I study optimal monetary policy and capital controls in an open economy New Keynesian model with endogenous portfolio choice. I develop an approximation method to characterize the solution sharply. The optimal policy balances two goals: (i) stabilizing output and inflation and (ii) enhancing the insurance properties of home-currency assets. The relative importance of these goals depends on the international portfolio. When the portfolio is optimally chosen, its exposure to home-currency fluctuations increases as the need for insurance grows, further amplifying the weight on insurance. This effect is significant. In a calibrated model for Canada, if the portfolio were held at its calibrated value rather than optimally chosen, the weight on insurance would be about five times smaller. Despite aggregate-demand externalities and incomplete markets, implementing the optimal portfolio does not require differential capital controls across asset classes.

Keywords: Optimal monetary policy; Exchange rate volatility; Incomplete markets; Portfolio choice; Capital controls; Macroprudential policy. (search for similar items in EconPapers)
JEL-codes: E52 F31 F41 (search for similar items in EconPapers)
Date: 2026-06
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