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Capital Controls and Financial Frictions in a Small Open Economy

Shigeto Kitano () and Kenya Takaku ()
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Kenya Takaku: Hiroshima City University

Open Economies Review, 2017, vol. 28, issue 4, 761-793

Abstract: Abstract We develop a small open economy model with financial frictions between domestic banks and foreign investors, and examine the welfare-improving effect of capital controls. We show that capital controls are effective in addressing the amplification effect due to financial frictions. As the degree of financial frictions increases, the welfare-improving effect of capital controls becomes larger and a more aggressive policy rule is appropriate. Comparing two economies, one with and one without “liability dollarization,” we also find that the welfare-improving effect of capital controls is larger in the presence of “liability dollarization,” and the difference between the effects becomes larger as the degree of financial frictions increases.

Keywords: Capital control; Financial frictions; Financial intermediaries; Balance sheets; Small open economy; Liability dollarization; DSGE; Welfare (search for similar items in EconPapers)
JEL-codes: E69 F32 F38 F41 (search for similar items in EconPapers)
Date: 2017
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