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Capital controls or exchange rate policy? A pecuniary externality perspective

Benigno, Gianluca and Chen, Huigang and Otrok, Christopher and Rebucci, Alessandro and Young, Eric R. (2012) Capital controls or exchange rate policy? A pecuniary externality perspective. CEP Discussion Papers, CEPDP1160. Centre for Economic Performance, London School of Economics and Political Science, London, UK.

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Identification Number: CEPDP1160

Abstract

In the aftermath of the global financial crisis, a new policy paradigm has emerged in which old-fashioned policies such as capital controls and other government distortions have become part of the standard policy toolkit (the so-called macro-prudential policies). On the wave of this seemingly unanimous policy consensus, a new strand of theoretical literature contends that capital controls are welfare enhancing and can be justified rigorously because of second-best considerations. Within the same theoretical framework adopted in this fast-growing literature, we show that a credible commitment to support the exchange rate in crisis times always welfare-dominates prudential capital controls as it can achieve the first best unconstrained allocation. In this benchmark economy, prudential capital controls are optimal only when the set of policy tools is restricted so that they are the only policy instrument available.

Item Type: Monograph (Discussion Paper)
Official URL: http://cep.lse.ac.uk/_new/publications/series.asp?...
Additional Information: © 2012 The Authors
Subjects: H Social Sciences > HB Economic Theory
JEL classification: E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E52 - Monetary Policy (Targets, Instruments, and Effects)
F - International Economics > F3 - International Finance > F37 - International Finance Forecasting and Simulation
F - International Economics > F4 - Macroeconomic Aspects of International Trade and Finance > F41 - Open Economy Macroeconomics
Sets: Departments > Economics
Collections > Economists Online
Research centres and groups > Centre for Economic Performance (CEP)
Series: Working Papers > CEP Discussion Papers
Date Deposited: 07 Aug 2013 13:37
Last Modified: 07 Aug 2013 13:37
URI: http://eprints.lse.ac.uk/id/eprint/51505

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