Capital Controls as Macro-prudential Policy in a Large Open Economy

Jonathan Davis and Michael Devereux

No 25710, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: The use of international capital flow controls has become increasingly popular in academic and policy circles. But almost all the recent literature studies the case of a small economy, ignoring the spillover effects of capital controls to the rest of the world. This paper re-examines the case for capital controls in a large open economy, where domestic financial constraints may bind following a large negative shock. We consider both ex-ante capital controls (prudential) and ex-post controls (crisis management). In a large open economy, there is a tension between the desire to tax capital inflows to manipulate the terms-of-trade and tax capital outflows for either prudential or crisis management purposes. When capital controls are chosen non-cooperatively, we show that ex-post capital controls are unsuccessful in alleviating financial constraints in a crisis, and ex-ante capital controls are unsuccessful at reducing financial instability before the crisis. Non-cooperative capital controls leave the crisis-hit country even worse off than in an environment with unrestricted capital flows. In addition, a non-cooperative equilibrium with capital controls actually increases the likelihood of a financial crisis occurring. By contrast, capital controls can be effective under international cooperation and can significantly ease financial constraints when applied ex-post for crisis management and reduce the likelihood of a crisis when used ex-ante for prudential purposes.

JEL-codes: F40 (search for similar items in EconPapers)
Date: 2019-03
New Economics Papers: this item is included in nep-mon and nep-opm
Note: IFM
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Citations: View citations in EconPapers (3)

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Working Paper: Capital Controls as Macro-prudential Policy in a Large Open Economy (2019)
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