Working Paper: NBER ID: w20805
Authors: Anton Korinek; Damiano Sandri
Abstract: We examine the effectiveness of capital controls versus macroprudential regulation in reducing financial fragility in a small open economy model in which there is excessive borrowing because of externalities associated with financial crises and contractionary exchange rate depreciations. We find that both types of instruments play distinct roles: macroprudential regulation reduces the indebtedness of leveraged borrowers whereas capital controls induce more precautionary behavior for the economy as a whole, including for savers. This reduces crisis risk by shoring up aggregate net worth and mitigating the transfer problem that occurs during crises. In advanced countries where the risk of large contractionary depreciations is more limited, the role for capital controls subsides. However, macroprudential regulation remains essential in our model to mitigate booms and busts in asset prices.
Keywords: capital controls; macroprudential regulation; financial fragility; emerging economies
JEL Codes: E44; F34; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| macroprudential regulation (G18) | indebtedness of leveraged borrowers (G32) |
| macroprudential regulation (G18) | financial stability (G28) |
| capital controls (F38) | precautionary behavior (D91) |
| precautionary behavior (D91) | crisis risk (H12) |
| capital controls (F38) | aggregate net worth (E10) |
| exchange rate depreciations (F31) | borrowing constraints (F34) |
| borrowing constraints (F34) | domestic demand (R22) |
| domestic demand (R22) | crises (H12) |