A New Dilemma: Capital Controls and Monetary Policy in Sudden Stop Economies / Michael B. Devereux, Eric R. Young, Changhua Yu.

Format:

Book

Author/Creator:

Devereux, Michael B.

Contributor:

National Bureau of Economic Research.

Young, Eric R.

Yu, Changhua.

Series:

Working Paper Series (National Bureau of Economic Research) no. w21791.

NBER working paper series no. w21791

Language:

English

Physical Description:

1 online resource: illustrations (black and white);

Other Title:

New Dilemma

Place of Publication:

Cambridge, Mass. National Bureau of Economic Research 2015.

Summary:

The dangers of high capital flow volatility and sudden stops have led economists to promote the use of capital controls as an addition to monetary policy in emerging market economies. This paper studies the benefits of capital controls and monetary policy in an open economy with financial frictions, nominal rigidities, and sudden stops. We focus on a time-consistent policy equilibrium. We find that during a crisis, an optimal monetary policy should sharply diverge from price stability. Without commitment, policymakers will also tax capital inflows in a crisis. But this is not optimal from an ex-ante social welfare perspective. An outcome without capital inflow taxes, using optimal monetary policy alone to respond to crises, is superior in welfare terms, but not time-consistent. If policy commitment were in place, capital inflows would be subsidized during crises. We also show that an optimal policy will never involve macro-prudential capital inflow taxes as a precaution against the risk of future crises (whether or not commitment is available).

Notes:

Print version record

December 2015.