Capital Flows and Monetary Policy
The series Working Papers on Economics is published by the Office for Economic Studies at the Banco de la República (Central Bank of Colombia). The works published are provisional, and their authors are fully responsible for the opinions expressed in them, as well as for possible mistakes. The opinions expressed herein are those of the authors and do not necessarily reflect the views of Banco de la República or its Board of Directors.
Capital inflows and outflows often remind policymakers of the monetary policy trilemma and the several associated dilemmas. To tackle these dilemmas, an equilibrium model of capital flows is proposed. The model captures bouts of capital inflows and outflows with shocks to the emerging-market country risk premium. From the equilibrium conditions of the model, an expression for the accounting of net foreign assets is derived. This expression helps study the evolution of foreign debt, during capital inflows and outflows, under fixed and floating exchange rates. A policy experiment is conducted for the case of a capital outflow. It shows that during a capital outflow an interest rate defense of the exchange rate can deliver a recession even in financially resilient economies. This is one possible explanation of the puzzle in Chari, Kehoe and McGrattan [AER Vol. 25 No. 2, 2005]
La serie Borradores de Economía es una publicación de la Subgerencia de Estudios Económicos del Banco de la República. Los trabajos son de carácter provisional, las opiniones y posibles errores son responsabilidad exclusiva del autor y sus contenidos no comprometen al Banco de la República ni a su Junta Directiva.
