CAPITAL CONTROL AND EFFECTS OF FISCAL AND MONETARY POLICY

This paper numerically analyzes the effectiveness of monetary and fiscal policies, and their associated risks, on growth rate, product volatility, inflation rate, exchange rate under capital controls, domestic interest rate, for- eign interest rate and foreign pricing volatility respectively by using an extended equilibrium in a stochastic dynamic optimal model with capital controls. The research results show that the effectiveness of the monetary policy and fiscal policy change with capital controls, domestic interest rate, foreign interest rate and foreign pricing volatility. Capital control has not affected the effects of Monetary and a fiscal policy on growth rate, product volatility, inflation rate and exchange rate for lower interest rate, and has no impact on the effects on growth rate and product volatility for higher interest rate. The impacts of capital controls on the effects of monetary and fiscal policy in lower product volatility country are same as that in higher product volatility country. After the classic Fleming(1962)- Mundell(1963) model was published, it has been extensively known that international capital mobility is an important factor for the effectiveness of money policy and fiscal policy in open economy. Mundell- Fleming model implies that the international capital mobility can raise effectiveness of money policy, and diminish the effectiveness of fiscal policy as measured in terms of its short-run effect on output in open economy. Sutherland (1996) and Senay (2000) presented the key result of the Mundell- Fleming model by using the general dynamic money equilibrium model developed by Obstfeld and Rogoff (1995), which can be used to analyze money policy effect on output. They show that the capital flow changing from imperfect to perfect can improve the effectiveness of money policy by using two countries sticky price model of Sutherland (1996) and Senay (2000). So, as Mundell-Fleming model implies, the higher international capital mobility is, the more effective money policy is, and capital mobility moving from imperfect to perfect diminishes the effectiveness of fiscal policy. Christian Pierdzioch (2004) use a dynamic general equilibrium two-country op- timizing 'new-open economy macroeconomics' model to analyze the consequences