Capital Controls and Trade Liberalization in a Monetary Economy

IMF Working Papers, March 1, 1999

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Capital Controls and Trade Liberalization in a Monetary Economy

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Bibliographic details

• Authors: B. Jang
• Published: March 1, 1999
• Series: IMF Working Papers
• DOI: https://doi.org/10.5089/9781451844122.001

Summary

• Reexamines Aizenman’s (1985) results on the effects of capital controls during unanticipated trade liberalization using an intertemporal optimizing monetary model.
• Modifies Aizenman’s currency substitution framework by treating foreign money as an interest-bearing asset whose major role is to smooth intertemporal consumption.
• Finds that with this modification, Aizenman’s results are reversed, indicating that the effects of capital controls during trade liberalization vary greatly depending on the role of foreign money in a country.
• Also studies the effects of an anticipated trade liberalization.

Main findings

• The role attributed to foreign money (currency substitution model vs. interest-bearing asset smoothing consumption) critically determines the direction of the effects of capital controls during trade liberalization.
• Under the model where foreign money is an interest-bearing asset, conclusions opposite to Aizenman (1985) emerge regarding capital controls during unanticipated trade liberalization.
• The paper extends analysis to anticipated trade liberalization and its distinct effects relative to unanticipated liberalization.

Methodology and assumptions

• Uses an intertemporal optimizing monetary model.
• Contrasts the currency substitution model (as used by Aizenman) with a framework in which foreign money is an interest-bearing asset that smooths intertemporal consumption.

Policy implications

• Policy conclusions about capital controls during trade liberalization are not robust to assumptions about the monetary role of foreign money.
• Policymakers should account for the functional role of foreign money in the economy (currency substitution versus interest-bearing asset) when evaluating the likely effects of capital controls associated with trade liberalization.
• Distinctions between unanticipated and anticipated trade liberalization matter for assessing capital control policies.

Content in this bundle

• Capital Controls and Trade Liberalization in a Monetary Economy - WP/99/24
  • Capital Controls and Trade Liberalization in a Monetary Economy - WP/99/24 (Markdown version)
  • Capital Controls and Trade Liberalization in a Monetary Economy - WP/99/24 (PDF)