TY  - JOUR
AU  - Farhi,Emmanuel
AU  - Werning,Ivan
TI  - Dealing with the Trilemma: Optimal Capital Controls with Fixed Exchange Rates
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 18199
PY  - 2012
Y2  - June 2012
UR  - http://www.nber.org/papers/w18199
L1  - http://www.nber.org/papers/w18199.pdf
N1  - Author contact info:
Emmanuel Farhi
Harvard University
Department of Economics
Littauer Center
Cambridge, MA 02138
Tel: 617/496-1835
Fax: 617/495-8570
E-Mail: efarhi@harvard.edu

Ivan Werning
MIT Department of Economics
50 Memorial Drive, E51-251a
Cambridge, MA 02142-1347
Tel: 617/452-3662
Fax: 617/253-1330
E-Mail: iwerning@mit.edu
AB  - We lay down a standard macroeconomic model of a small open economy with a fixed exchange rate and study optimal capital controls (defined as maximizing the utility of a representative household). We provide sharp analytical and numerical characterizations for a variety of shocks. We find that capital controls are employed to respond to some shocks but not others. They are particularly effective to address risk-premium shocks that affect the interest rate differential foreign investors require in a particular country. We also discuss how the solution depends on the degree of nominal rigidity and the openness of the economy. We show that capital controls may be optimal even if the exchange rate is not fixed in response to risk premium shocks or if wages, in addition to prices, are sticky. Finally, we compare the single country’s optimum to a coordinated world solution. Our results show a limited need for coordination. However, the uncoordinated solution features the same capital controls as the coordinated solution.
ER  -