On the Desirability of Capital Controls

Abstract:

In the first part we study a standard two country international macro model we ask whether shutting down the market for international non-contingent borrowing and lending is ever desirable. The answer is yes. Imposing capital controls is unilaterally desirable when initial conditions are such that ruling out bond trade generates a sufficiently favorable change in the expected path for the terms of trade. Imposing capital controls can be welfare improving for both countries for calibrations in which equilibrium terms of trade movements improve insurance against country specific shocks. I n the second part we study capital controls in environments with rigid labor markets. There the case for capital controls can be stronger, and is based on the fact that capital inflows can increase the cost of labor, thereby inducing unemployment.