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Chapter 30: Problem 5

The global financial crisis of \(2007-2009\) led some economists and policymakers to suggest reinstituting capital controls - or limits on the flow of foreign exchange and financial investments across countries - which existed in many European countries prior to the \(1960 \mathrm{~s}\). Why would a financial crisis lead policymakers to reconsider using capital controls? What problems might result from reinstituting capital controls?

Short Answer

Expert verified
The financial crisis might lead policymakers to reconsider using capital controls mainly as a tool to prevent damaging capital outflows, manage exchange rates and provide greater stability during the economic turmoil. However, the reintroduction of such controls can lead to a slowdown in economic growth, market distortions, discourage foreign investment, and might also induce corruption and rent-seeking behaviors.

Step by step solution

01

Identifying why a financial crisis leads to the reconsideration of capital controls

Economic instability and financial crises have the capacity to lead to massive capital outflows from a country. This could in turn weaken its economy further. Thus, in times of financial crisis, policymakers often consider the reintroduction of capital controls to prevent such massive outflows and stabilize the economy. This stability is largely because capital controls can help manage exchange rates, prevent economic instability caused by volatile capital flows, and provide the government with more control over the economy.
02

Pointing out the potential problems of reinstituting capital controls

While capital controls can bring with them a certain measure of stability and control, they can also lead to several problems. For instance, they can slow down economic growth and create distortions in the market by disrupting free market mechanisms. Capital controls can also discourage foreign investment and may lead to corruption and rent-seeking behaviors due to market distortions.

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Most popular questions from this chapter

The United States and most other countries abandoned the gold standard during the \(1930 \mathrm{~s}\). Why would the 1930 have been a particularly difficult time for countries to remain on the gold standard? (Hint: Think about the macroeconomic events of the \(1930 \mathrm{~s}\) and about the possible problems with carrying out an expansionary monetary policy while remaining on the gold standard.)

In January \(2007,\) before the financial crisis, the exchange rate was \(\$ 1.30\) per euro. In July 2008 , during the financial crisis, the exchange rate was \(\$ 1.58\) per euro. Was this change in the dollar-euro exchange rate good news or bad news for U.S. firms exporting goods and services to Europe? Was it good news or bad news for European consumers buying goods and services imported from the United States? Briefly explain.

What does it mean when one currency is "pegged" against another currency? Why do countries peg their currencies? What problems can result from pegging?

(Related to the Don't Let This Happen to You on page 1061 ) Briefly explain whether you agree with the following statement: "The Federal Reserve is limited in its ability to issue paper currency by the amount of gold the federal government has in Fort Knox. To issue more paper currency, the government first has to buy more gold."

(Related to the Apply the Concept on page 1067 ) An article in USA Today argued, "lronically, the euro's falland the benefit for German exports -is largely the result of eurozone policies that Germany has taken the lead in opposing ... [including] easier money policies by the European Central Bank." a. How does the "euro's fall" benefit German exports? b. How is the euro's fall related to policies of the European Central Bank?
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