Real Exchange Rate Overshooting and Capital Controls in a Crisis

This paper investigates the impact of a financial crisis on the attitude towards financial reforms, in an economy partially integrated with the global capital market. I identify conditions under which a crisis induces greater financial openness, mitigating the real exchange rate overshooting. The welfare gains from alleviating the shortage of funds in the sort run should be balanced with the cost of selling domestic equities at a discount. Even if the net gain from opening up the capital market is significant, it will exceed the gain from temporary capital controls only if the FDI is associated with significant favourable productivity effects.