Capital controls and exchange rates in a small open economy

This thesis argues that if a government lacks credibility, it may have to restrict capital movements to stabilize successfully its economy. However, capital controls always entail some costs, and in general, they will reduce society's welfare. Furthermore, countries which achieve macroeconomic stability will find that the costs of these restrictions will exceed any benefits, and it will therefore become advisable to abolish these controls.; Capital controls are usually implemented to defend an exchange rate regime. Colombia had these restrictions and a crawling peg system for 25 years. This made for an interesting scenario to study the relationship among the crawling exchange rate, the real exchange rate (RER), and other real and nominal macroeconomic variables.; The second part of the dissertation shows that changes in the nominal exchange rate have had only short-term effects on the RER in Colombia, and that this impact has been decreasing during the last years. For this reason, a general equilibrium model of the structural determinants of the RER is developed. An estimation of the model finds that increases in government expenditures, even with a balanced budget, will appreciate the RER. Likewise, growth of per-capita income and the higher productivity of the tradable goods sector have similar effects.; Finally, this study shows how the recent opening of Colombia's economy, greater capital mobility, and changes in the exchange rate regime have altered the relationship between the nominal exchange rate and the long-run price level. Monetary policy is presently less effective, and there is now a strong relationship between the nominal exchange rate and the price level.