This paper quantitatively compares the effects of domestic and international shocks on the macroeconomic volatility and households' welfare under the models with and without capital control, by incorporating capital control policy into a small open economy. The simulation results suggest that China's capital control can help reduce the macroeconomic volatility caused by the international shocks and increase macroeconomic stability. However, while facing domestic shocks, capital controls may improve net exports while damaging household consumption, so policy benefits are very limited. With the presence of both shocks, the overall effect of capital controls is still considerable. In the situation without capital control, the same domestic and international shocks can cause more movements of foreign asset holding by the household, and the exchange rate and other macroeconomic variables may become more volatile, then leading to welfare loss of the household. Besides, this study also finds that the size of foreign reserves will affect the welfare improvement of capital control policy. The more foreign reserves that the central bank holds, the more the welfare improvement of implementing capital control. As a result, the welfare loss of opening the capital account will be large considering the fact that the Chinese central bank holds too much foreign reserves. Therefore, we should be cautious about capital account liberalization.
Key words
Capital Control /
Foreign Asset /
Economic Fluctuation /
Welfare Analysis
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Footnotes
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