A managed policy on capital inflows in a small open economy

Cross-border capital flows create dilemmas and tradeoffs for economic policy. We use game theory in a multi-period economy to analyze conditions under which a developing country’s government restricts capital inflows. We show if the local economic conditions are strong but sound regulatory reforms are not in place, the government will restrict capital inflows, all else being equal. The restrictions on capital inflows have large impact on short-term capital inflows. For direct foreign investment in a developing country, the restrictions tend to be less desirable because the benefits of foreign investment tend to dominate the costs.