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Capital Controls or Exchange Rate Policy? A Pecuniary Externality Perspective

Gianluca Benigno, Huigang Chen, Christopher Otrok (), Alessandro Rebucci () and Eric Young ()

CEP Discussion Papers from Centre for Economic Performance, LSE

Abstract: In the aftermath of the global financial crisis, a new policy paradigm has emerged in which old-fashioned policies such as capital controls and other government distortions have become part of the standard policy toolkit (the so-called macro-prudential policies). On the wave of this seemingly unanimous policy consensus, a new strand of theoretical literature contends that capital controls are welfare enhancing and can be justified rigorously because of second-best considerations. Within the same theoretical framework adopted in this fast-growing literature, we show that a credible commitment to support the exchange rate in crisis times always welfare-dominates prudential capital controls as it can achieve the first best unconstrained allocation. In this benchmark economy, prudential capital controls are optimal only when the set of policy tools is restricted so that they are the only policy instrument available.

Keywords: Capital controls; exchange rate policy; financial frictions; financial crises; financial stability; optimal taxation; prudential policies; planning problem (search for similar items in EconPapers)
JEL-codes: E52 F37 F41 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
Date: 2012-08
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Working Paper: Capital controls or exchange rate policy? A pecuniary externality perspective (2012) Downloads
Working Paper: Capital controls or exchange rate policy? a pecuniary externality perspective (2012) Downloads
Working Paper: Capital Controls or Exchange Rate Policy? A Pecuniary Externality Perspective (2012) Downloads
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