Capital Controls as Macro-prudential Policy in a Large Open Economy / J. Scott Davis, Michael B. Devereux.

Format:

Book

Author/Creator:

Davis, J. Scott.

Contributor:

National Bureau of Economic Research.

Devereux, Michael B.

Series:

Working Paper Series (National Bureau of Economic Research) no. w25710.

NBER working paper series no. w25710

Language:

English

Physical Description:

1 online resource: illustrations (black and white);

Place of Publication:

Cambridge, Mass. National Bureau of Economic Research 2019.

Summary:

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.

Notes:

Print version record

March 2019.