Capital Controls: A Normative Analysis

36 Pages Posted: 9 Feb 2013

See all articles by Bianca De Paoli

Bianca De Paoli

London School of Economics & Political Science (LSE) - Centre for Economic Performance (CEP)

Anna Lipinska

Board of Governors of the Federal Reserve System

Date Written: February 1, 2013

Abstract

Countries' concerns about the value of their currency have been studied and documented extensively in the literature. Capital controls can be — and often are — used as a tool to manage exchange rate fluctuations. This paper investigates whether countries can benefit from using such a tool. We develop a welfare-based analysis of whether (or, in fact, how) countries should tax international borrowing. Our results suggest that restricting international capital flows through the use of these taxes can be beneficial for individual countries, although it would limit cross-border pooling of risk. The reason is because, while consumption risk-pooling is important, individual countries also care about domestic output fluctuations. Moreover, the results show that countries decide to restrict the international flow of capital exactly when this flow is crucial to ensure cross-border risk sharing. Our findings point to the possibility of costly "capital control wars" and thus to significant gains from international policy coordination.

Keywords: capital controls, welfare, international asset markets

JEL Classification: E61, F41, G15

Suggested Citation

De Paoli, Bianca and Lipinska, Anna, Capital Controls: A Normative Analysis (February 1, 2013). FRB of New York Staff Report No. 600, Available at SSRN: https://ssrn.com/abstract=2213321 or http://dx.doi.org/10.2139/ssrn.2213321

Bianca De Paoli (Contact Author)

London School of Economics & Political Science (LSE) - Centre for Economic Performance (CEP) ( email )

Houghton Street
London WC2A 2AE
United Kingdom

Anna Lipinska

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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