Economics at your fingertips  

Evaluating the role of capital controls and monetary policy in emerging market crises

Michael B. Devereux and Changhua Yu

Journal of International Money and Finance, 2019, vol. 95, issue C, 189-211

Abstract: This paper explores the interactive role of optimal monetary policy and capital controls in dealing with ‘sudden-stop’ financial crises in emerging market economies. The model features collateral constraints embedding pecuniary externalities, as well as nominal rigidities in prices and wages. We explore the role of policy commitment and macro-prudential motives in the design of optimal monetary and capital market responses to crises, under alternative exchange rate regimes. We find that policy commitment is very important under flexible exchange rates, but commitment (to the path of capital taxes) is only of minor benefit under an exchange rate peg. As regards macro-prudential policy, we find the exact opposite. Under floating exchange rates, the optimal policy has almost no macro-prudential elements. On the other hand, when authorities are constrained by an exchange rate peg, macro-prudential policy is used aggressively as part of an optimal policy framework. An important additional finding is that the direction of capital controls is different under a fixed relative to a flexible exchange rate. With flexible exchange rates, policy makers impose inflow taxes immediately at the onset of a crisis. Under pegged exchange rates, they will impose capital inflow subsidies.

Keywords: Sudden stops; Pecuniary externality; Monetary policy; Capital controls; Commitment versus discretion (search for similar items in EconPapers)
JEL-codes: E44 E58 F38 F41 (search for similar items in EconPapers)
Date: 2019
References: Add references at CitEc
Citations: Track citations by RSS feed

Downloads: (external link)
Full text for ScienceDirect subscribers only

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link:

Access Statistics for this article

Journal of International Money and Finance is currently edited by J. R. Lothian

More articles in Journal of International Money and Finance from Elsevier
Bibliographic data for series maintained by Dana Niculescu ().

Page updated 2019-09-23
Handle: RePEc:eee:jimfin:v:95:y:2019:i:c:p:189-211