The first few months of 2020 saw a large outflow of capital from emerging economies. Consider one
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Question:
The first few months of 2020 saw a large outflow of capital from emerging economies. Consider one such economy with a tradable and a non-tradable sector, which has its currency pegged to the US dollar. As a policymaker in this country, you are given two options to keep your peg. The first option is to respond to the capital outflow by imposing capital controls, knowing that this will lead to protectionism and the creation of rents in the tradable sector. The second option is to raise nominal interest rates. What are the separate channels by which each of these two options lead to a loss in output? In comparing them, provide one argument in favour of each option relative to the other.
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