Working Paper: NBER ID: w24443
Authors: Viral V. Acharya; Arvind Krishnamurthy
Abstract: We examine theoretically the role of reserves management and macro-prudential capital controls as ex-post and ex-ante safeguards, respectively, against sudden stops, and argue that these measures are complements rather than substitutes. Absent capital controls, reserves to be deployed ex post are partially undone ex ante by short-term capital flows, a form of moral hazard from the insurance provided by reserves in sudden stops. Ex ante capital controls offset this distortion and thereby increase the benefit of holding reserves. Thus, these instruments are complements. With foreign investment flows into both domestic and external borrowing markets, capital controls need to account for the possibility of regulatory arbitrage between the markets. Through the lens of the model, we analyze movements in foreign reserves, external debt, and the range of capital controls being employed by one large emerging market, viz. India.
Keywords: capital flow management; macroprudential policy; reserves management; emerging markets
JEL Codes: E44; F3; G01; G18
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| reserves management (E63) | capital controls (F38) |
| capital controls (F38) | reserves management (E63) |
| effective capital controls (F38) | moral hazard from reserves (H84) |
| without capital controls (F38) | diminished benefits of reserves (J32) |
| capital controls (F38) | regulatory arbitrage (G18) |
| reserves management (E63) | effectiveness in managing capital flows (F32) |
| stronger capital controls (F38) | reduced likelihood of sudden stops (R48) |
| stronger capital controls (F38) | currency crises (F31) |