Question

1. Assume China is a large open economy country and it want to use optimal capital controls measures. List 2 benefits of the measure and discuss why China (select a large open economy) can use optimal capital controls measures but individuals cannot.

Answer 1

Capital control represents any measure taken by a government, central bank, or other regulatory body to limit the flow of foreign capital in and out of the domestic economy. These controls include taxes, tariffs, legislation, volume restrictions, and market-based forces. These are established to regulate financial flows from capital markets into and out of a country's capital account. These controls can be economy-wide or specific to a sector or industry. optimal capital controls alternate between taxes on inflows during crises to subsidies towards inflows after crises, and this is designed to ease the tightness of financial constraints during crises.

Benefits of the measure includes -

• The biggest benefit of capital controls is that it prevents overheating in economies. This means that it prevents investors from pumping and dumping an economy. Investors cannot flood the economy with funds drive up output and prices and then suddenly leave causing everything to crash.
• Monetary policy autonomy is another important motivation behind the imposition of capital controls. It makes the monetary policy more effective.
• capital controls can restrict foreign ownership of certain domestic assets (such as natural resources) or strategic sectors (such as banking or telecommunications).

Large open economies like China can adopt optimal capital control measures but individuals can't because in large countries like China there is excess of capital available in domestic market so if they restrict foreign capitals there will not be any shortage of capital but if individuals restrict there can be very heavy shortage of capital because these countries are poor, small and have less capital available in domestic economy.