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A new approach to capital control for emerging market economies
Institution:1. Seoul National University Business School, 1 Gwanak Ro, Gwanak Gu, Seoul 08826, Korea;2. Department of Statistics and Actuarial Science, Soongsil University, 369 Sangdo-Ro, Dongjak-Gu, Seoul 06978, Korea;1. Department of Business Administration, National Chin-Yi University of Technology, No. 57, Sec. 2, Zhongshan Rd., Taiping Dist., Taichung 41170, Taiwan;2. Department of Business Administration, Fu Jen Catholic University, No. 510, Zhongzheng Rd., Xinzhuang Dist., New Taipei City 242062, Taiwan;3. Department of Money and Banking, National Chengchi University, No. 64, Sec. 2, Zhinan Rd., Taipei 11605, Taiwan;1. College of Business Administration, Hunan University, Changsha 410082, China;2. College of Finance and Statistics, Hunan University, Changsha 410079, China;3. Business School, Ningbo University, Ningbo 315211, China;1. Department of Statistical and Mathematical Methods in Economics, University of Economics in Katowice, 1-go Maja St 50, 40-287 Katowice, Poland;2. Department of Insurance and Capital Markets, Faculty of Management, University of Warsaw, Szturmowa St 1/3, 02-678 Warsaw, Poland
Abstract:The present paper proposes a new approach to capital control for emerging market economies, which restricts capital inflows to a fraction of the gap between foreign currency denominated loans and deposits in the economy. We show that the foreign-currency-gap capital control proposed here outperforms tax-based capital control in attenuating the negative effects of external shocks on business cycle fluctuations. This attenuation effect works via the interest rate channel and the capital control constraint itself. Compared to tax-based capital control, the foreign-currency-gap capital control is welfare enhancing, effectively mitigating financial instability with little cost in terms of macroeconomic stability. Countries with a high level of foreign currency denominated loans and deposits need to implement a stricter foreign-currency-gap capital control.
Keywords:Capital control  Foreign currency denomination  Open economy macroeconomics  Financial friction  Welfare analysis  Emerging market economy  DSGE
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