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Capital Flows and Policy Dilemmas

Paper Session

Friday, Jan. 3, 2020 2:30 PM - 4:30 PM (PDT)

Marriott Marquis, Solana
Hosted By: American Economic Association
  • Chair: Louphou Coulibaly, University of Pittsburgh

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

Scott Davis
,
Federal Reserve Bank of Dallas
Michael Devereux
,
University of British Columbia

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.

A Macroprudential Theory of Foreign Reserve Accumulation

Fernando Arce
,
University of Minnesota
Julien Bengui
,
University of Montréal
Javier Bianchi
,
Federal Reserve Bank of Minneapolis

Abstract

This paper proposes a theory of international reserves as a macroprudential policy tool. In a dynamic model with overborrowing externalities, we show that the constrained-efficient allocations can be implemented with reserve accumulation. The optimal reserve accumulation policy leans against the wind and significantly reduces the exposure to financial crisis. The theory is consistent with the joint dynamics of private and official capital flows, both over time and in the cross section.

The Global Financial Resource Curse

Gianluca Benigno
,
London School of Economics
Luca Fornaro
,
Center for Research in International Economics (CREI)
Martin Wolf
,
University of Vienna

Abstract

This paper provides a model in which forming a monetary union fosters financial integration by eliminating currency risk. Higher financial integration can lead to a better allocation of capital across the members of the monetary union, and thus higher welfare. Higher financial integration, however, can also lead to perverse outcomes, characterized by capital flights out of capital-scarce countries toward the rest of the union. The model thus suggests that active policy interventions on the financial markets might be needed to ensure that forming a currency union has a positive impact on welfare.

Monetary Policy in Sudden Stops-Prone Economies

Louphou Coulibaly
,
University of Pittsburgh

Abstract

Monetary policy procyclicality is a pervasive feature of emerging market economies. In this paper, I propose a parsimonious theory explaining this fact in a model where access to foreign financing depends on the real exchange rate and the government lacks commitment. The discretionary monetary policy is procyclical to mitigate balance sheet effects originating from exchange rate depreciations during sudden stops. Committing to an inflation targeting regime is found to increase social welfare and reduce the frequency of financial crises, despite increasing their severity. Finally, the ability to use capital controls induces a less procyclical discretionary monetary policy and delivers higher welfare gains than an inflation targeting regime by reducing both the frequency and the severity of crises.
Discussant(s)
Stephanie Schmitt-Grohé
,
Columbia University
Pablo Ottonello
,
University of Michigan
Julien Bengui
,
University of Montreal & Bank of Canada
Felipe Saffie
,
University of Maryland
JEL Classifications
  • F0 - General
  • E0 - General