Capital control and monetary policy coordination: Tobin tax revisited

Abstract

With the relaxation of capital controls and enriching capital flow channels, the potential negative impact of short-term capital flight on emerging market economies (EMEs), such as China, has been developing. This paper develops a small open-economy dynamic stochastic general equilibrium (DSGE) model to address the policy coordination between capital control and monetary policy, thereby introducing the Tobin tax on capital flow. We simulate the applicability of the Tobin tax and its collaboration with monetary policy in the context of crossborder capital flows triggered by external monetary policy spillovers. Regarding the capital outflow from EMEs caused by the external monetary policy, we find that “enterprises Tobin tax + interest rate cut” or “household Tobin tax + interest rate hike” can prevent capital outflow. Based on the welfare analysis, we find that the former is more feasible. The simulation results suggest that although the Tobin tax can ease the pressures on monetary authority by restraining short-term capital outflows, its ability to stabilize the financial markets is limited.