CAPITAL CONTROL AND DOMESTIC INTEREST RATES: A GENERALIZED MODEL

• Published in: Contemporary economic policy Vol. 23; no. 3; pp. 456 - 464
• Main Author: HSU, HSIAO-TANG
• Format: Journal Article
• Language: English
• Published: Oxford, UK Blackwell Publishing Ltd 01.07.2005; Western Economic Association International; Blackwell Publishers Ltd; Western Economic Association
• Series: Contemporary Economic Policy
• Subjects: Capital; Capital flow; Economic aspects; Economic models; Forecasts and trends; Interest rates; International economic relations; Market trend/market analysis; Moral hazard; Output rate; World economy; Malaysia
• ISSN: 1074-3529; 1465-7287
• DOI: 10.1093/cep/byi034

This article addresses the question of capital control (inflow) and its varied effect on interest rates and real‐side economy. The moral hazard problem causes interest rates to increase as a function of external debt. Decreased capital inflow (external debt) can reduce moral hazard and outweigh the effect of costly capital transactions, with capital control decreasing interest rates and increasing output. This result runs counter to other theoretical works on capital control. The policy implication is that a government can generate national gains from capital inflow control by prohibiting new external debt (borrowing from abroad). With old debt retired and no new borrowing from abroad, external debt is reduced. This will reduce the moral hazard problem and lead to a drop in interest rates and an increase in output. (JEL F32, F41, E43)