Capital Controls Spillovers

In the last decade, some emerging economies have imposed capital controls to reduce the volatility of capital flows and to manage the exchange rate. However, a capital controls tightening in some countries is likely to deflect capital flows to other countries with no controls in place. In this paper I set up an international business cycle model with three countries (one AE and two symmetric EMEs) to analyze these spillovers effects. I find that if one EME restricts its financial account to curb capital inflows, the latter are partially deflected to the other EME, whose economic activity expands. Moreover, I find that capital controls are desirable for the two EMEs: these policy tools allow them to affect the interest rate at which they trade international bonds. Nevertheless, if EMEs coordinate when they set capital controls, welfare gains, compared to the Nash equilibrium, are negligible