Capital%20Controls%20or%20Real%20Exchange%20Rate%20Policy%3F%20A%20Pecuniary%20Externality%20Perspective

Working Papers

Capital Controls or Real Exchange Rate Policy? A Pecuniary Externality Perspective


CODE: IDB-WP-393
AUTHOR(s): Benigno, Gianluca , Chen, Huigang , Otrok, Christopher , Rebucci, Alessandro , Young, Eric
PUBLISHED: March 2013
LANGUAGE: English
RELATED TOPICS: Macroeconomics
DOWNLOAD FILE IN: English

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 tool kit (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, this paper shows that a credible commitment to support the exchange rate in crisis times always welfare-dominates prudential capital controls, as it can achieve unconstrained allocation.

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