International Finance Discussion Papers (IFDP)

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February 2017

Capital Controls and Monetary Policy Autonomy in a Small Open Economy

J. Scott Davis and Ignacio Presno

Abstract:

Is there a link between capital controls and monetary policy autonomy in a country with a floating currency? Shocks to capital flows into a small open economy lead to volatility in asset prices and credit supply. To lessen the impact of capital flows on financial instability, a central bank funds it optimal to use the domestic interest rate to "manage" the capital account. Capital account restrictions affect the behavior of optimal monetary policy following shocks to the foreign interest rate. Capital controls allow optimal monetary policy to focus less on the foreign interest rate and more on domestic variables.

Keywords: capital controls; credit constraints; small open economy

DOI: https://doi.org/10.17016/IFDP.2017.1190

PDF: Full Paper

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Last Update: January 09, 2020