Capital Controls, Global Liquidity Traps, and the International Policy Trilemma

The zero bound on interest rates introduces a new dimension to the trilemma in international policy. The openness of the international financial market might render monetary policy ineffective, even within a system of fully flexible exchange rates, because shocks that lead to a liquidity trap in one...

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Bibliographic Details
Published in:The Scandinavian journal of economics 2014-01, Vol.116 (1), p.158-189
Main Authors: Devereux, Michael B., Yetman, James
Format: Article
Language:English
Subjects:
Capital controls
Capital mobility
Consumer economics
Demand shocks
Economic policy
Economic theory
Financial openness
Flexible exchange rates
Foreign policy
Global economy
Interest rates
International
International capital market
International monetary policy
international transmission
Liquidity
Liquidity trap
Monetary policy
Monetary theory
Optimal policy
Optimal taxation
Studies
Zero bound
zero lower bound
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Summary:The zero bound on interest rates introduces a new dimension to the trilemma in international policy. The openness of the international financial market might render monetary policy ineffective, even within a system of fully flexible exchange rates, because shocks that lead to a liquidity trap in one country are propagated through financial markets to other countries. However, the effectiveness of monetary policy can be restored by the imposition of capital controls. We derive the optimal response of monetary policy to a global liquidity trap in the presence of capital controls. We show that, even though capital controls might facilitate effective monetary policy, capital controls are not generally desirable in terms of welfare.
ISSN:0347-0520
1467-9442
DOI:10.1111/sjoe.12040