In a standard two-country international macro model, we ask whether imposing restrictions on international non contingent borrowing and lending is ever desirable. The answer is yes. If one country imposes capital controls unilaterally, it can generate favorable changes in the dynamics of equilibrium interest rates and the terms of trade, and thereby benefit at the expense of its trading partner. If both countries simultaneously impose capital controls, the welfare effects are ambiguous. We identify calibrations in which symmetric capital controls improve terms of trade insurance against country-specific shocks and thereby increase welfare for both countries.
Published in: _IMF Economic Review_ (Vol. 64, No. 1, May 2016, pp. 75-102) https://doi.org/10.1057/imfer.2016.7.