Capital controls and welfare

This paper computes welfare levels under different degree of capital controls and compares them with the welfare level under perfect capital mobility by using the methodology of Schmitt-Grohe and Uribe (2007). We show that perfect capital mobility is not always optimal and that capital controls may enhance an economy's welfare level. There exists an optimal degree of capital-account restriction that achieves a higher level of welfare than that under perfect capital mobility, if the economy has costly financial intermediaries. The results of our analysis imply that as the domestic financial intermediaries are less efficient, the government should impose stricter capital controls in the form of a tax on foreign borrowing. (C) 2011 Elsevier Inc. All rights reserved.