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Capital controls and foreign currency denomination

Fernando Garcia-Barragan () and Guangling Liu ()

No 671, Working Papers from Economic Research Southern Africa

Abstract: This paper studies the effectiveness of capital controls with foreign currency denomination and its welfare implications. To do this, we develop a general equilibrium model with financial frictions and banking, in which assets and liabilities are denominated in both domestic and foreign currencies. We propose a non-pecuniary capital-control policy that limits the gap between foreign-currency denominated loans and deposits to the amount of foreign funds that bankers can borrow from the international credit market. We show that capital controls have a critical impact on the dynamics of assets and liabilities that are denominated in foreign currency. This critical impact works through the capital control constraint on quantitative nancial variables directly, not through the spreads. The non-pecuniary capital controls help to stabilize the nancial sector and, hence, reduces the negative spillovers to the real economy. A more restrictive capital-control policy signicantly attenuates the welfare effect of the foreign monetary policy and exchange rate shocks.

Keywords: Capital control; Foreign currency denomination; Open economy macroeconomics; Financial friction; Welfare analysis; DSGE (search for similar items in EconPapers)
JEL-codes: E32 E44 E58 F38 F41 (search for similar items in EconPapers)
Pages: 28 pages
Date: 2017-02
New Economics Papers: this item is included in nep-cba, nep-dge, nep-ifn, nep-mac, nep-mon and nep-opm
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Persistent link: https://EconPapers.repec.org/RePEc:rza:wpaper:671

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