Capital Controls and Foreign Exchange Market Intervention

On January 31, 2018, Wednesday, at 4:15 pm in Pettengill G21, “Capital Controls and Foreign Exchange Market Intervention” was presented by Jae Hoon Choi, Assistant Professor of Economics from Xavier University.

Abstract:  Small open economy models based on the classical Mundell’s trilemma are unable to explain the coexistence of capital controls and volatile exchange rates, which has become a robust feature in emerging market economies. The paper presents a novel theoretical approach by extending the standard New Keynesian small open economy model by building upon the Gali-Monacelli and Farhi-Werning frameworks. In this model, the policymaker decides the optimal international monetary policy portfolio of the level of managed exchange rate regimes, the level of capital controls, and the domestic interest rates. I further assume that breaking exchange rate peg signals the country’s economic instability and financial sector responds by raising the country’s risk premium, which creates a financial friction in the system. The results show that the coexistence of managed float and capital controls becomes optimal. Furthermore, the financial friction has a multiplying effect, which makes exchange rate stabilization important to prevent a bigger welfare loss. The model also captures that optimal capital controls indirectly manage exchange rate depreciation, which allow policymakers to put less resources to stabilize exchange rates.

Sponsored by The Casey Lecture Fund – Economics