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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: Faculty of International Studies, Hiroshima City University, Japan

No DP2016-34, Discussion Paper Series from Research Institute for Economics & Business Administration, Kobe University

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)
New Economics Papers: this item is included in nep-dge, nep-mon and nep-opm
Date: 2016-10, Revised 2017-05
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https://www.rieb.kobe-u.ac.jp/academic/ra/dp/English/DP2016-34.pdf Revised version, 2017 (application/pdf)

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Journal Article: Capital Controls and Financial Frictions in a Small Open Economy (2017) Downloads
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