In response to a temporary change in total factor productivity, the adoption of capital controls under a flexible exchange rate

Question

Quizplus · Accepted Answer

Capital controls can limit the flow of capital into and out of a country, which can help dampen the effect of a temporary change in total factor productivity on the nominal exchange rate because it limits the ability of investors to quickly move their money in and out of the country. At the same time, by limiting the flow of capital, capital controls can also dampen the effect of the productivity shock on domestic output. Therefore, choice D is the best option as it correctly identifies that capital controls dampen the effect on both domestic output and the nominal exchange rate.

In Response to a Temporary Change in Total Factor Productivity