Capital Controls and the Real Exchange Rate

Capital import taxes lower (raise) world (home) interest rates. This shifts home expenditure from the present to the future and foreign expenditure from the future to today. With identical home and foreign expenditure patterns, the change in the composition of world expenditure has no effects on demand for any commodity. Then capital controls have no effect on the real exchange rate. When consumers prefer home goods, capital controls cause lower demand today for home goods. In this way, capital controls lower the real exchange rate today. This result is mitigated when the country imposing capital controls is a large debtor.