Exchange Rate Policy, Capital Controls, and Economic Stability

A computable general equilibrium (CGE) model with§financial markets was built to simulate the effects§of capital control policies in Argentina under§alternative exchange rate regimes. The two types of§capital control tested are a required reserve deposit§on short-term capital inflows and a limit on capital§flight. The main channel through which the financial§and real sides of the economy interact in this model§is bank lending.§§For the flexible exchange rate simulations, each type§of capital control has the effect of diminishing the§impact of external financial shocks on key§macroeconomic variables. The introduction of capital§controls has the undesirable effect of decreasing§private national income and investment, in addition§to triggering a currency appreciation. It is§therefore unclear whether the costs outweigh the§benefits in this setting. The costs of introducing§capital controls in the fixed exchange rate§simulations are lower than in the flexible exchange§rate model. While simulations for both capital§control policies yield mixed results in the fixed§exchange rate model, each type of control provides§some improvements in the model's response to external§shocks.