## The Effects of Capital Controls on Exchange Rate Volatility and Output

_IMF Working Papers, November 1, 2001_

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## Bibliographic details
- Authors: Christiane Nickel, Günter Schmidt, Georg Stadtmann, Michael Frenkel
- Published: November 1, 2001
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781451859515.001

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### Summary
- This paper extends the Dornbusch model of overshooting exchange rates to discuss both exchange rate and output effects of capital controls that involve additional costs for international asset transactions.
- The paper shows that capital controls:
  - Have the merit of reducing the volatility of exchange rates following a monetary shock.
  - Increase exchange rate volatility in the short run.
  - Induce costs for the real sector in the form of lower equilibrium output levels.

### Key findings and mechanisms
- Extension of the Dornbusch overshooting model to incorporate additional costs for international asset transactions.
- Exchange rate effects:
  - Reduced exchange rate volatility following a monetary shock (merit of capital controls).
  - Increased exchange rate volatility in the short run after implementing capital controls.
- Real sector effects:
  - Implementation of capital controls induces costs for the real sector manifested as lower equilibrium output levels.
- Emphasis on expectations and dynamics:
  - Exchange rate expectation and exchange rate effect are central to the analysis.
  - Interaction between interest rate, nominal exchange rate, price level, and goods market drives outcomes.

### Policy implications and considerations
- Capital controls that impose additional costs on international asset transactions can stabilize exchange rates after monetary shocks but can have adverse short-run volatility effects and lower equilibrium output.
- Policymakers should weigh:
  - The trade-off between reduced volatility following shocks and increased short-run volatility at implementation.
  - The potential cost to the real sector through lower equilibrium output levels.
- The paper provides a theoretical framework for assessing the effectiveness of capital controls, including quantity control and capital constraint considerations.

### Metadata and classification
- Authors: Christiane Nickel, Günter Schmidt, Georg Stadtmann, Michael Frenkel
- Publication date: November 1, 2001
- Series: Working Paper No. 2001/187
- Issue: 187
- Volume: 2001
- Pages: 30
- DOI: https://doi.org/10.5089/9781451859515.001
- Stock No: WPIEA1872001
- ISBN: 9781451859515
- ISSN: 1018-5941
- Subject: Balance of payments, Capital controls, Capital flows, Capital inflows, Exchange rate adjustments, Exchange rates, Foreign exchange
- Keywords: aggregate supply, capital constraint, capital control, capital controls, capital flows, Capital inflows, effectiveness of the capital control, exchange rate, Exchange rate adjustments, exchange rate effect, exchange rate expectation, exchange rate volatility, Exchange rates, expectations of the market, Global, goods market, interest rate, introduction of the capital control, nominal exchange rate, price level, purpose of the capital control, quantity control, sovereign bond, WP

*IMF Working Paper — The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy.*

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_Source: https://www.imf.org/en/publications/wp/issues/2016/12/30/the-effects-of-capital-controls-on-exchange-rate-volatility-and-output-15446_