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Capital Controls as Macro-prudential Policy in a Large Open Economy

No. 358

J. Scott Davis and Michael B. Devereux

Abstract: The literature on optimal capital controls for macro-prudential policy has focused on capital controls in a small open economy. This ignores the spillover effects to the rest of the world. This paper re-examines the case for capital controls in a large open economy, where domestic financial constraints may bind following a large negative shock. There is a tension between the desire to tax inflows to manipulate the terms of trade and tax outflows for macro-prudential purposes. Non-cooperative capital controls are ineffective as macro-prudential policy. Cooperative policy will ignore terms-of-trade manipulation and thus cooperative capital controls yield more effective macro-prudential policy.

DOI: https://doi.org/10.24149/gwp358

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