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Macroeconomic adjustment with managed exchange rates and capital controls: Some lessons from China

Jennifer Lai (), Hongyi Chen and Paul McNelis ()

Economic Modelling, 2020, vol. 91, issue C, 759-768

Abstract: This paper examines the performance of capital controls and exchange-rate management when the economy finds itself in dark corners. These are times when the real sector experiences a sequence of prolonged negative shocks from world demand, while the central bank faces low world interest rates on its foreign-exchange reserve holdings. We examine two regimes, one of a fixed exchange rate with strong capital controls and another with a more open capital account with a managed exchange rate. We show how this model replicates recent experiences of China as it moved from a relatively fixed exchange rate regime with strong capital controls to a more flexible exchange rate regime with a more open capital account. Our results show that capital-account liberalization should be accompanied by domestic price liberalization to avoid large losses in foreign exchange reserve and jumps in unemployment during dark corners in the more open regime.

Keywords: Ramsey rule; Dark corner dynamics; Sequencing of reforms (search for similar items in EconPapers)
JEL-codes: E58 (search for similar items in EconPapers)
Date: 2020
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DOI: 10.1016/j.econmod.2019.10.027

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