Exchange rate policy, capital controls, and economic stability in Argentina: A CGE modeling approach

A computable general equilibrium (CGE) model with financial markets was built to simulate the effects of capital control policies in the Argentine economy under alternative exchange rate regimes. The two types of capital control tested are a required reserve deposit on short-term capital inflows and a limit on capital flight. The main channel through which the financial and real sides of the economy interact in this model is bank lending. Changes in capital market conditions affect the availability of credit, directly affecting the ability of firms to borrow for their working capital and investment financing needs. For the flexible exchange rate model simulations, each type of capital control has the effect of diminishing the impact of external financial shocks on key macroeconomic variables. While this is desirable, the introduction of either kind of capital control (in the absence of external shocks) has the undesirable effect of decreasing private national income and investment, in addition to triggering a currency appreciation. It is not clear whether the costs outweigh the benefits in a flexible exchange rate setting. The costs of introducing either capital control policy in the fixed exchange rate model simulations are lower than in the flexible exchange rate model. While simulations for both capital control policies yield mixed results in the fixed exchange rate model, each type of control provides some improvements in the model's response to external shocks.