Beware the Side Effects: Capital Controls, Trade and Misallocation

Eugenia Andreasen, Sofia Bauducco, Evangelina Dardati and Enrique Mendoza

No 30963, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: Capital controls are an effective credit-management tool but they have serious side effects. Analyzing a dynamic Melitz-OLG model in which firms face credit constraints, we find that capital controls worsen misallocation and hurt exports. Misallocation worsens through static effects that lower capital-labor ratios and raise firm prices. In addition, changes in saving incentives induce dynamic effects and changes in wages, aggregate demand and the real exchange rate cause general equilibrium effects. A quantitative analysis calibrated to Chile’s capital controls of the 1990s yields a sizable worsening in misallocation, with stronger effects on firms that are exporters, more productive, or far from their optimal scales. Exports and the share of exporting firms fall sharply. Rebating the revenue that capital controls may generate or using loan-to-value regulation instead of capital controls results in sharply weaker effects, but slightly tighter capital controls strengthens them significantly. A set of empirical tests applied to Chilean firm-level data provide robust support for the model’s key predictions.

JEL-codes: F12 F38 F41 O47 (search for similar items in EconPapers)
Date: 2023-02
New Economics Papers: this item is included in nep-dge and nep-int
Note: IFM
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