This paper studies the effects of prohibiting individuals from holding
foreign assets, and of allowing firms to trade in foreign assets only up to
what is needed to finance export and import activities. Although firms can
perform arbitrage between domestic and foreign financial markets, the
distortions in asset markets are not fully arbitraged away but instead they are
transmitted to domestic goods market. The paper discusses the effects of
shocks in foreign financial markets and in domestic fiscal policy. We show
that the dynamics and steady states are crucially affected by capital controls.
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