Optimal Capital Controls and Real Exchange Rate Policies: A Pecuniary Externality Perspective

65 Pages Posted: 9 May 2016 Last revised: 23 Sep 2022

See all articles by Gianluca Benigno

Gianluca Benigno

London School of Economics & Political Science (LSE) - Department of Economics; Federal Reserve Bank of New York

Huigang Chen

MarketShare Partners

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

Multiple version iconThere are 3 versions of this paper

Date Written: May 2016

Abstract

A new theoretical literature studies the use of capital controls to prevent financial crises in models in which pecuniary externalities justify government intervention. Within the same theoretical framework, we show that when ex-post policies such as defending the exchange rate can contain or resolve financial crises, there is no need to intervene ex-ante with capital controls. On the other hand, if crises management policies entail some efficiency costs, then crises prevention policies become part of the optimal policy mix. In the standard model economy used in the literature with costly crisis management policies, the optimal policy mix combines capital controls in tranquil times with support for the real exchange rate to limit its depreciation during crises times. The optimal policy mix yields more borrowing and consumption, a lower probability of financial crisis, and twice as large welfare gains than in the socially planned equilibrium with capital controls alone.

Suggested Citation

Benigno, Gianluca and Benigno, Gianluca and Chen, Huigang and Otrok, Christopher and Rebucci, Alessandro and Young, Eric R., Optimal Capital Controls and Real Exchange Rate Policies: A Pecuniary Externality Perspective (May 2016). NBER Working Paper No. w22224, Available at SSRN: https://ssrn.com/abstract=2777312

Gianluca Benigno (Contact Author)

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

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Huigang Chen

MarketShare Partners ( email )

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Christopher Otrok

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Alessandro Rebucci

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Eric R. Young

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