Foreign Exchange Reserves as a Tool for Capital Account Management

Jonathan Davis, Ippei Fujiwara, Kevin Huang () and Jiao Wang

No 352, Globalization Institute Working Papers from Federal Reserve Bank of Dallas

Abstract: Many recent theoretical papers have argued that countries can insulate themselves from volatile world capital flows by using a variable tax on foreign capital as an instrument of monetary policy. But at the same time many empirical papers have argued that only rarely do we observe these cyclical capital taxes used in practice. In this paper we construct a small open economy model where the central bank can engage in sterilized foreign exchange intervention. When private agents can freely buy and sell foreign bonds, sterilized foreign exchange intervention has no effect. But we analytically prove that when private agents cannot freely buy and sell foreign bonds, that is, under acyclical capital controls, optimal sterilized foreign exchange intervention is equivalent to an optimally chosen tax on foreign capital. Numerical simulations of the model show that a variable capital tax is a reasonable approximation for sterilized foreign exchange intervention under the levels of capital controls observed in many emerging markets.

Keywords: Central bank; small open economy; foreign exchange reserves; capital controls (search for similar items in EconPapers)
JEL-codes: E30 E50 F40 (search for similar items in EconPapers)
Pages: 51 pages
Date: 2019-02-05
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Related works:
Journal Article: Foreign exchange reserves as a tool for capital account management (2021)
Working Paper: Foreign exchange reserves as a tool for capital account management (2019)
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Persistent link: https://EconPapers.repec.org/RePEc:fip:feddgw:352

DOI: 10.24149/gwp352

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