Working Paper

The Prudential Use of Capital Controls and Foreign Currency Reserves

Abstract: We provide a simple framework to study the prudential use of capital controls and currency reserves that have been explored in the recent literature. We cover the role of both pecuniary externalities and aggregate demand externalities. The model features a central policy dilemma for emerging economies facing large capital outflows: the choice between increasing the policy rate to stabilize the exchange rate and decreasing the policy rate to stabilize employment. Ex ante capital controls and reserve accumulation can help mitigate this dilemma. We use our framework to survey the recent literature and provide an overview of recent empirical findings on the use of these policies.

Keywords: Capital controls; foreign exchange interventions; Monetary policy; Macroprudential policies;

JEL Classification: F32; F33; F41; F42; G18;

https://doi.org/10.21034/wp.787

Bibliographic Information

Provider: Federal Reserve Bank of Minneapolis

Part of Series: Working Papers

Publication Date: 2021-11-12

Number: 787