Optimal Monetary Policy and Capital Account Restrictions in a Small Open Economy

2013-33 | February 1, 2015

Declines in interest rates in advanced economies during the global financial crisis resulted in surges in capital flows to emerging market economies and triggered advocacy of capital control policies. We evaluate the effectiveness for macroeconomic stabilization and the welfare implications of the use of capital account policies in a monetary DSGE model of a small open economy. Our model features incomplete markets, imperfect asset substitutability, and nominal rigidities. In this environment, policymakers can respond to fluctuations in capital flows through capital account policies such as sterilized interventions and taxing capital inflows, in addition to conventional monetary policy. Our welfare analysis suggests that optimal sterilization and capital controls are complementary policies.

Article Citation

Spiegel, Mark M., and Zheng Liu. 2013. “Optimal Monetary Policy and Capital Account Restrictions in a Small Open Economy,” Federal Reserve Bank of San Francisco Working Paper 2013-33. Available at https://doi.org/10.24148/wp2013-33

About the Authors
Zheng Liu
Zheng Liu is a vice president and director of the Center for Pacific Basin Studies in the Economic Research Department of the Federal Reserve Bank of San Francisco. Learn more about Zheng Liu
Mark Spiegel
Mark Spiegel is a senior policy advisor in the Economic Research Department of the Federal Reserve Bank of San Francisco. Learn more about Mark Spiegel