L16 - Capital Controls And Trade Barriers

Question 1

Recall NCF consists of multiple components:

What can restrictions do to them?
One of em is a policy choice, which one?

Answer 1

1. FDI
2. Portfolio
3. Official sector (CB) flows -policy choice

Source of perfect capital mobility in 1 and 2, restrictions can limit that

Question 2

How do we model restrictions on NCF, and how do capital controls allow policy to operate (two-stage process)

Answer 2

Assume NCF=0 (extreme assumption tho, implies one choice of ē available)

Then BOP requires CA=0

1. Select fixed ē to ensure trade balance NX(ē)=0
2. Control r as desired

Question 3

What is the difference in the extent to which the CB can borrow/lend ie what kind of NCF > / < 0 are sustainable?

Answer 3

What is sustainable:

CA (+) + NCF (-) = 0

CB can recycle trade surpluses as official-sector capital outflows
SO NCF<0 sustainable

BUT same dynamic can’t work for trade deficits, continual borrowing

Question 4

What does it imply about restrictions with capital controls? Not that NCF=0, BUT

Answer 4

NCF <= 0

So approx
NX(ē) >= 0

Capital controls sustainable provided ē undervalued relative to trade balance

Question 5

Graphs for over/undervalued currency and how that relates to IS-MP, and a fixed r* (1)

What are the implications for an overvalued currency?

Answer 5

See (1)

Need capital inflows to maintain trade deficit

Question 6

So are capital controls a good solution to the trilemma?

Answer 6

Nope!

Not all countries can have a sufficiently undervalued ē, will have competitive devaluation and episodic crises afterwards

Question 7

Barriers to trade allow for scope to change NX independently of e.r. Policy.

What kind of possible dimensions are there and how do we model this?

Answer 7

Tariffs
Quotas
Product standards

NX(e, ψ)

Increased psy, greater import restrictions so NX increasing in it

Question 8

What kind of consequences are there for trade restrictions?

Answer 8

Both supply and demand side, in former LRAS suffers

But basically can shift NX for given e

Question 9

Implications of ψ for eq’m income? If we have floating e and fixed M (2)

Answer 9

The MONEY market gives our single eq’m Y, so we can do whatever we want on D-side and nothing will change in aggregate, though may have LR/compositional effects

Gains offset by appreciation

Question 10

With fixed rates…

Answer 10

IS becomes dominant determinant of Y, given Y money market adjusts