IMF Economic Review

, Volume 64, Issue 1, pp 75–102 | Cite as

On the Desirability of Capital Controls

  • Jonathan Heathcote
  • Fabrizio Perri


In a standard two-country international macro model, the paper asks whether imposing restrictions on international noncontingent borrowing and lending is ever desirable. The answer is yes. If one country imposes capital controls unilaterally, it can generate favorable changes in the dynamics of equilibrium interest rates and the terms of trade, and thereby benefit at the expense of its trading partner. If both countries simultaneously impose capital controls, the welfare effects are ambiguous. The paper identifies calibrations in which symmetric capital controls improve terms-of-trade insurance against country-specific shocks and thereby increase welfare for both countries.

JEL Classifications

F32 F41 F42 

Supplementary material (15 kb)
Supplementary material, approximately 15 KB.


  1. Aguiar, M. and G. Gopinath, 2007, “Emerging Market Business Cycles: The Cycle is the Trend,” Journal of Political Economy, Vol. 115, No. 1, pp. 69–102.CrossRefGoogle Scholar
  2. Backus, D.K., P.J. Kehoe, and F.E. Kydland, 1994, “Dynamics of the Trade Balance and the Terms of Trade: The J-Curve?,” American Economic Review, Vol. 84, No. 1, pp. 84–103.Google Scholar
  3. Baxter, M. and M.J. Crucini, 1995, “Business Cycles and the Asset Structure of Foreign Trade,” International Economic Review, Vol. 36, No. 4, pp. 821–54.CrossRefGoogle Scholar
  4. Benigno, G., H. Chen, C. Otrok, A. Rebucci, and E.R. Young, 2015, “Optimal Capital Controls and Real Exchange Rate Policies: A Pecuniary Externality Perspective,” Working Paper (London School of Economics).Google Scholar
  5. Bianchi, J., 2011, “Overborrowing and Systemic Externalities in the Business Cycle,” American Economic Review, Vol. 101, No. 7, pp. 3400–26.CrossRefGoogle Scholar
  6. Brandt, M.W., J.H. Cochrane, and P. Santa-Clara, 2006, “International Risk Sharing is Better Than You Think, or Exchange Rates are Too Smooth,” Journal of Monetary Economics, Vol. 53, No. 4, pp. 671–98.CrossRefGoogle Scholar
  7. Brunnermeier, M. and Y. Sannikov, 2015, “International Credit Flows and Pecuniary Externalities,” American Economic Journal: Macroeconomics, Vol. 7, No. 1, pp. 297–338.Google Scholar
  8. Cole, H.L. and M. Obstfeld, 1991, “Commodity Trade and International Risk Sharing: How Much Do Financial Markets Matter?,” Journal of Monetary Economics, Vol. 28, No. 1, pp. 3–24.CrossRefGoogle Scholar
  9. Corsetti, G., L. Dedola, and S. Leduc, 2008, “International Risk Sharing and the Transmission of Productivity Shocks,” Review of Economic Studies, Vol. 75, No. 2, pp. 443–73.CrossRefGoogle Scholar
  10. Costinot, A., G. Lorenzoni, and I. Werning, 2014, “A Theory of Capital Controls as Dynamic Terms-of-Trade Manipulation,” Journal of Political Economy, Vol. 122, No. 1, pp. 77–128.CrossRefGoogle Scholar
  11. De Paoli, B. and A. Lipinska, 2013, Capital Controls: A Normative Analysis, Federal Reserve Bank of New York Staff Report 600.Google Scholar
  12. Edwards, S., 1989, “Tariffs, Capital Controls, and Equilibrium Real Exchange Rates,” Canadian Journal of Economics, Vol. 22, No. 1, pp. 79–92.CrossRefGoogle Scholar
  13. Farhi, E. and I. Werning, 2013, “A Theory of Macroprudential Policies in the Presence of Nominal Rigidities,” NBER Working Paper 19313.Google Scholar
  14. Gourinchas, P.-O. and O. Jeanne, 2013, “Capital Flows to Developing Countries: The Allocation Puzzle,” Review of Economic Studies, Vol. 80, No. 4, pp. 1484–1515.CrossRefGoogle Scholar
  15. Hart, O., 1975, “On the Optimality of the Equilibrium when the Market Structure is Incomplete,” Journal of Economic Theory, Vol. 11, No. 3, pp. 418–43.CrossRefGoogle Scholar
  16. Heathcote, J. and F. Perri, 2002, “Financial Autarky and International Business Cycles,” Journal of Monetary Economics, Vol. 49, No. 3, pp. 601–27.CrossRefGoogle Scholar
  17. Heathcote, J. and F. Perri, 2013, “The International Diversification Puzzle is Not as Bad as You Think,” Journal of Political Economy, Vol. 121, No. 6, pp. 1108–59.CrossRefGoogle Scholar
  18. Heathcote, J. and F. Perri, 2014, “Assessing International Efficiency,” in Handbook of International Economics, Vol. 4, ed. by G. Gopinath, E. Helpman and K. Rogoff (Amsterdam: Elsevier), pp. 523–82.CrossRefGoogle Scholar
  19. Jeske, K., 2006, “Private International Debt with Risk of Repudiation,” Journal of Political Economy, Vol. 114, No. 3, pp. 576–93.CrossRefGoogle Scholar
  20. Johnson, H.G., 1953, “Optimum Tariffs and Retaliation,” Review of Economic Studies, Vol. 21, pp. 142–53.CrossRefGoogle Scholar
  21. Korinek, A., 2010, “Regulating Capital Flows to Emerging Markets: An Externality View,” Working Paper (Johns Hopkins University).Google Scholar
  22. Lucas Jr. R.E., 1987, Models of Business Cycles (Oxford: Basil Blackwell).Google Scholar
  23. Magud, N.E., C.M. Reinhart, and K.S. Rogoff, 2011, “Capital Controls: Myth and Reality—A Portfolio Balance Approach,” NBER Working Paper 16805.Google Scholar
  24. Martin, A. and F. Taddei, 2012, “International Capital Flows and Credit Market Imperfections: A Tale of Two Frictions,” Journal of International Economics, Vol. 89, No. 2, pp. 441–52.CrossRefGoogle Scholar
  25. Neumeyer, P.A. and F. Perri, 2005, “Business Cycles in Emerging Economies: The Role of Interest Rates,” Journal of Monetary Economics, Vol. 52, No. 2, pp. 345–80.CrossRefGoogle Scholar
  26. Newbery, D.M.G. and J.E. Stiglitz, 1984, “Pareto Inferior Trade,” Review of Economic Studies, Vol. 51, No. 1, pp. 1–12.CrossRefGoogle Scholar
  27. Schmitt-Grohe, S. and M. Uribe, 2003, “Closing Small Open Economy Models,” Journal of International Economics, Vol. 61, No. 1, pp. 163–85.CrossRefGoogle Scholar
  28. Schmitt-Grohe, S. and M. Uribe, forthcoming, “Downward Nominal Wage Rigidity, Currency Pegs, and Involuntary Unemployment,” Journal of Political Economy.Google Scholar
  29. Stiglitz, J.E., 1982, “The Inefficiency of the Stock Market Equilibrium,” Review of Economic Studies, Vol. 49, No. 2, pp. 241–61.CrossRefGoogle Scholar

Copyright information

© International Monetary Fund 2016

Authors and Affiliations

  • Jonathan Heathcote
  • Fabrizio Perri

There are no affiliations available

Personalised recommendations