Capital controls and monetary policy in sudden-stop economies

This paper develops a New Keynesian model with sovereign debt and default. We focus on domestic interest rules governing monetary policy and external foreign currency government debt that is defaultable. Monetary policy and default risk interact as they both impact domestic consumption and production. We find that default risk generates monetary frictions, which amplify the monetary response to shocks. Large sovereign default risk depresses domestic consumption and production. These monetary frictions in turn discipline sovereign borrowing, resulting in slower debt accumulation and lower spreads. Our framework replicates the positive co-movements of sovereign spreads with domestic nominal rates and inflation, a salient feature of emerging markets data, and can rationalize the experience of Brazil during the 2015 downturn, with high inflation, nominal rates, and sovereign spreads. A counterfactual experiment shows that, by raising the domestic rate, the Brazilian central bank not only reduced inflation but also alleviated the debt crisis. * We thank our discussants Giancarlo Corsetti, Radek Paluszynski, and Vivian Yue for insightful comments and suggestions. The views expressed herein are those of the authors and not necessarily those of the Federal Reserve Bank of Minneapolis or the Federal Reserve System. Contact

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“…The trade elasticity ρ is set at 5, as in Devereux et al (2019). This number is within the range of estimates in the trade elasticity literature.…”

Section: Parameterizationmentioning

confidence: 99%

Monetary Policy and Sovereign Risk in Emerging Economies (NK-Default)

Arellano

Bai

Mihalache

2020

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“…3 Temporary capital account restrictions can help stabilize large fluctuations in capital inflows (Ostry et al, 2010). However, the welfare effects of such capital flow taxes depend on whether or not policy commitment is available (Devereux et al, 2018). Properly designed, temporary capital account policies can serve as a useful tool to mitigate the effects of external shocks (Farhi and Werning, 2012;Unsal, 2013;Davis and Presno, 2017).…”

Section: Related Literaturementioning

confidence: 99%

Capital Controls and Income Inequality

Liu¹,

Spiegel²,

Zhang³

2020

ERWP

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We examine the distributional implications of capital account policy in a small open economy model with heterogeneous agents and financial frictions. Households save through deposits in both domestic and foreign banks. Entrepreneurs finance investment with borrowed funds from domestic banks and foreign investors. Domestic banks engage in costly intermediation of deposits from households and loans to entrepreneurs. Government capital account policy consists of taxes on outflows and inflows. Given policy, a temporary decline in the world interest rate leads to a surge in inflows, benefiting entrepreneurs and hurting households. Raising inflow taxes or reducing outflow taxes mitigate this redistribution. However, in the long run liberalization of either inflows or outflows reduces inequality. The model's short-run implications are supported by empirical evidence. Based on instrumental variable estimation with a panel of emerging market economies, we demonstrate that increases in private capital inflows raise income inequality, while increases in outflows reduce it. These effects are significant and robust to a wide variety of empirical specifications.

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“…Recently, researchers have become increasingly interested in controlling the chaos in economic systems by different methods [9,10,11,12,13]. Ott, Grebogi and Yorke [14] proposed the OGY control method, which was successfully applied to chaos control in some economic systems [15,16].…”

Section: Introductionmentioning

confidence: 99%

Chaos Control of a Resource-Economic-Pollution Dynamic System

Yin

Huang

Fan

2019

JERR

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How to control chaos in the economic system has aroused the interest of researchers. We research the chaos control in a new Resource-Economic-Pollution system by time-delayed feedback control. By determining the appropriate range of time delay τ and feedback strength k, the chaotic phenomena of the system are controlled. We verify the linear stability and the existence of Hopf bifurcation of the system. Numerical simulations show that chaos control can eliminate the chaotic behavior of the system and stabilize the system at the equilibrium point. When the time lag term is in a certain interval, the chaotic phenomenon of the system will disappear and the system will be controlled in a stable state. In practice, due to capacity and financial constraints, the firm or the government often restrains output through many methods to confine the range of fluctuations in these variables. This shows that the government or corporate decision makers have often used this approach consciously or unconsciously to promote steady economic growth.

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Capital controls and monetary policy in sudden-stop economies

Cited by 61 publications

References 43 publications

Monetary Policy and Sovereign Risk in Emerging Economies (NK-Default)

Monetary Policy and Sovereign Risk in Emerging Economies (NK-Default)

Capital Controls and Income Inequality

Chaos Control of a Resource-Economic-Pollution Dynamic System

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