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On the timing and optimality of capital controls: Public expenditures, debt dynamics and welfare

Authors


  • We are most grateful to the editor, Kazuo Nishimura, and to Patrick Pintus for encouraging this work. Special thanks go to a referee for stimulating observations which have improved the paper. Boucekkine acknowledges the financial support of the French Community of Belgium through an ARC grant on sustainability.

Email: raouf.boucekkine@univ-amu.fr

Abstract

This paper solves a second-best problem where a government has to choose whether to tax financial inflows (capital controls) or not, and when. A multi-stage optimal control technique is used to this end. First, it is shown that it is optimal to switch in finite time from capital controls to full financial liberalization whenever a measure of total wealth is above a certain threshold. In particular, a too large initial debt makes financial liberalization sub-optimal. Second, capital controls should be used countercyclically. Third, financial liberalization is not unaffordable only for poor countries, even wealthy countries might find it optimal to implement capital controls if they aim to keep a large amount of public expenditure.

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