Macroeconomic adjustment with managed exchange rates and capital controls: Some lessons from China |
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Institution: | 1. School of Management, University of Science and Technology of China, 96 Jinzhai Road, Hefei, 230026, China;2. Department of Economics and Finance, City University of Hong Kong, 83 Tat Chee Avenue, Kowloon, Hong Kong;3. School of International Finance, Guangdong University of Foreign Studies, 2 Baiyun Avenue, Guangzhou, 510420, China |
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Abstract: | This paper examines the performance of capital controls and exchange-rate management when the economy finds itself in dark corners. These are times when the real sector experiences a sequence of prolonged negative shocks from world demand, while the central bank faces low world interest rates on its foreign-exchange reserve holdings. We examine two regimes, one of a fixed exchange rate with strong capital controls and another with a more open capital account with a managed exchange rate. We show how this model replicates recent experiences of China as it moved from a relatively fixed exchange rate regime with strong capital controls to a more flexible exchange rate regime with a more open capital account. Our results show that capital-account liberalization should be accompanied by domestic price liberalization to avoid large losses in foreign exchange reserve and jumps in unemployment during dark corners in the more open regime. |
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Keywords: | Ramsey rule Dark corner dynamics Sequencing of reforms E58 F41l |
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