Capital Controls or Exchange Rate Policy? A Pecuniary Externality Perspective

FRB of St. Louis Working Paper No. 2012-025A

27 Pages Posted: 2 Aug 2012

See all articles by Gianluca Benigno

Gianluca Benigno

London School of Economics & Political Science (LSE) - Department of Economics

Chris Otrok

University of Missouri; Federal Reserve Banks - Federal Reserve Bank of St. Louis

Alessandro Rebucci

Johns Hopkins University - Carey Business School; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Eric R. Young

University of Virginia

Huigang Chen

MarketShare Partners

Multiple version iconThere are 2 versions of this paper

Date Written: July 28, 2012

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.

Keywords: Capital Controls, Exchange Rate Policy, Financial Frictions, Financial Crises, Financial Stability, Optimal Taxation, Prudential Policies, Planning Problem

JEL Classification: E52, F37, F41

Suggested Citation

Benigno, Gianluca and Otrok, Christopher and Rebucci, Alessandro and Young, Eric R. and Chen, Huigang, Capital Controls or Exchange Rate Policy? A Pecuniary Externality Perspective (July 28, 2012). FRB of St. Louis Working Paper No. 2012-025A . Available at SSRN: https://ssrn.com/abstract=2121715 or http://dx.doi.org/10.2139/ssrn.2121715

Gianluca Benigno

London School of Economics & Political Science (LSE) - Department of Economics ( email )

Houghton Street
London WC2A 2AE
United Kingdom
+44 20 7955 7807 (Phone)

Christopher Otrok (Contact Author)

University of Missouri ( email )

118 Professional Building
Columbia, MO 65211
United States

Federal Reserve Banks - Federal Reserve Bank of St. Louis ( email )

411 Locust St
Saint Louis, MO 63011
United States

Alessandro Rebucci

Johns Hopkins University - Carey Business School ( email )

100 International Drive
Baltimore, MD 21202
United States

HOME PAGE: http://carey.jhu.edu/faculty-research/faculty-directory/alessandro-rebucci-phd

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Eric R. Young

University of Virginia ( email )

1400 University Ave
Charlottesville, VA 22903
United States

Huigang Chen

MarketShare Partners ( email )

11150 Santa Monica Boulevard
Los Angeles, CA 90025
United States

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