Capital Controls and Currency Wars

Capital controls and other forms of capital account intervention lead to international spillover effects that have recently raised concerns about global currency wars. This paper analyzes the welfare effects and the desirability of global coordination of such policy measures. We find that if controls are designed to correct for domestic externalities, the resulting equilibrium is nonetheless Pareto efficient, i.e. a global planner would impose the same measures and there is no role for global coordination. We illustrate this for a range of externalities that have recently been invoked as reasons for imposing capital controls: learning externalities, aggregate demand externalities in a liquidity trap, and pecuniary externalities arising from financial constraints. On the other hand, if controls are designed to manipulate a country’s terms-of-trade or if policymakers face an imperfect set of instruments, such as targeting problems or costly enforcement, then multilateral coordination is desirable in order to mitigate the inefficiencies arising from such imperfections.