Capital Controls, Global Liquidity Traps, and the International Policy Trilemma

Michael Devereux and James Yetman

Scandinavian Journal of Economics, 2014, vol. 116, issue 1, 158-189

Abstract: The zero bound on interest rates introduces a new dimension to the trilemma in international policy. The openness of the international financial market might render monetary policy ineffective, even within a system of fully flexible exchange rates, because shocks that lead to a liquidity trap in one country are propagated through financial markets to other countries. However, the effectiveness of monetary policy can be restored by the imposition of capital controls. We derive the optimal response of monetary policy to a global liquidity trap in the presence of capital controls. We show that, even though capital controls might facilitate effective monetary policy, capital controls are not generally desirable in terms of welfare.

Date: 2014
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https://doi.org/10.1111/sjoe.12040

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Working Paper: Capital Controls, Global Liquidity Traps and the International Policy Trilemma (2013)
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