Optimal capital controls and real exchange rate policies: A pecuniary externality perspective

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

LSE Research Online Documents on Economics from London School of Economics and Political Science, LSE Library

Abstract: In response to the global Önancial crisis a new policy paradigm emerged in which capital controls and other quantitative restrictions on credit áows have become part of the standard crisis prevention policy toolkit. A new strand of theoretical literature studies the use of capital controls in a context in which pecuniary externality justiÖes policy interventions. Within the same theoretical framework adopted in this literature, we show that the optimal design of crisis prevention (ex-ante) policies depends on the e§ectiviness of crisis management (ex-post) policies. This interaction between ex-ante and ex-post policies gives rise to a new rationale for the use of capital controls. SpeciÖcally, we show that when ex-post policies are e§ective in containing crises, there is no need to intervene ex-ante with capital controls. On the other hand, if crises management policies entail e¢ ciency costs and hence lose e§ectiveness, then the optimal policy mix consists of both ex-ante and ex-post interventions so that crises prevention policies become desirable. In our model, the optimal policy mix combines capital controls in tranquil times with real exchange rate support to limit its depreciation during crises times and yields welfare gains of more than 1% in consumption equivalence terms.

Keywords: Capital Controls; Real Exchange Rate Policy; Financial Frictions; Financial Crises; Financial Stability; Optimal Taxation; Macro-Prudential Policies. Markets; International Bond Markets; Mutual Funds. (search for similar items in EconPapers)
JEL-codes: E52 F37 F41 (search for similar items in EconPapers)
Pages: 33 pages
Date: 2015-02-25
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

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Related works:
Journal Article: Optimal capital controls and real exchange rate policies: A pecuniary externality perspective (2016)
Working Paper: Optimal capital controls and real exchange rate policies: a pecuniary externality perspective (2016)
Working Paper: Optimal Capital Controls and Real Exchange Rate Policies: A Pecuniary Externality Perspective (2016)
Working Paper: Optimal Capital Controls and Real Exchange Rate Policies: A Pecuniary Externality Perspective (2015)
Working Paper: Optimal Capital Controls and Real Exchange Rate Policies: A Pecuniary Externality Perspective (2014)
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