Foreign exchange reserves as a tool for capital account management

Abstract Recent theoretical papers argue that countries can insulate themselves from volatile world capital flows by using a variable tax on foreign as an instrument of monetary policy. But empirical we rarely observe these cyclical flow taxes used in practice. We construct small open economy model where the central bank engages sterilized exchange intervention. When private agents freely trade bonds, intervention has no effect. prove when frictions prevent free optimal is equivalent to capital. The then calibrated match levels account restrictions data. For openness many emerging market economies, close approximation for