Working Papers

2020-14 | September 2020

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Capital Controls and Income Inequality

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We examine the implications of capital account policy, in the form of capital flow taxes, for income distribution in a small open economy with heterogeneous agents and financial frictions. Banks engage in costly intermediation between household savings and entrepreneur investment. Our model predicts that permanent liberalization of either capital inflows or outflows reduces income inequality, but temporary inflow surges disproportionately raise entrepreneur income, exacerbating inequality. Instrumental variable estimation with a panel of emerging market economies confirms our model's short-run predictions, with robust evidence that income inequality rises with private capital inflows and falls with outflows.

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Article Citation

Liu, Zheng, Mark M. Spiegel, and Jingyi Zhang. 2020. "Capital Controls and Income Inequality," Federal Reserve Bank of San Francisco Working Paper 2020-14. Available at https://doi.org/10.24148/wp2020-14