## Capital Controls and Trade Liberalization in a Monetary Economy

_IMF Working Papers, March 1, 1999_

## Source details

**Canonical URL:** [Capital Controls and Trade Liberalization in a Monetary Economy](https://www.imf.org/en/publications/wp/issues/2016/12/30/capital-controls-and-trade-liberalization-in-a-monetary-economy-2895)

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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

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### 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.

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## Content in this bundle

- **Capital Controls and Trade Liberalization in a Monetary Economy - WP/99/24**
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_Source: https://www.imf.org/en/publications/wp/issues/2016/12/30/capital-controls-and-trade-liberalization-in-a-monetary-economy-2895_