The Illusive Quest: Do International Capital Controls Contribute to Currency Stability?

Abstract

We investigate the effectiveness of capital controls in insulating economies from currency crises, focusing in particular on both direct and indirect effects of capital controls and how these relationships may have changed over time in response to global financial liberalization and the greater mobility of international capital. We predict the likelihood of currency crises using standard macroeconomic variables and a probit equation estimation methodology with random effects. We employ a comprehensive panel data set comprised of 69 emerging market and developing economies over 1975-2004. Both standard and duration-adjusted measures of capital control intensity (allowing controls to-depreciate‖ over time) suggest that capital controls have not effectively insulated economies from currency crises at any time during our sample period. Maintaining real GDP growth and limiting real overvaluation are critical factors preventing currency crises, not capital controls. However, the presence of capital controls greatly increases the sensitivity of currency crises to changes in real GDP growth and real exchange rate overvaluation, making countries more vulnerable to changes in fundamentals. Our model suggests that emerging markets weathered the 2007-08 crisis relatively well because of strong output growth and exchange rate flexibility that limited overvaluation of their currencies.

India’s Trilemma: Financial Liberalisation, Exchange Rates and Monetary Policy1

“…3 3 A few countries, notably China, have resisted this trend. China maintains strict controls on international capital flows, which, together with a massive build‐up in international reserves, allow the maintenance of a rigid exchange rate and a large degree of monetary independence (MI) (Glick and Hutchison, 2010). …”

Currency Crises, Exchange Rate Regimes and Capital Account Liberalization: A Duration Analysis Approach

“…11 The outcome of their analysis suggests that even after controlling for the sample selection bias, countries with liberalized capital accounts experience a lower likelihood of speculative attacks. Glick and Hutchison (2010) present a new version of their earlier study. They expand the time coverage from 1975 to 2004 and apply duration-adjusted measures of capital control intensity to allow for changes in control programs over time.…”

Precaution versus mercantilism: Reserve accumulation, capital controls, and the real exchange rate

“…Because of a pecuniary externality in the model, Bianchi (2011) and Jeanne and Korinek (2010) call for capital controls; meanwhile Benigno, Chen, Otrok, Rebucci, and Young (2016) call for exchange rate policy during the crisis, instead of ex-ante capital controls. Turning to the data, Glick and Hutchison (2011) claim that capital controls have not effectively insulated economies from currency crises in recent years. However, Bussière et al (2015) argue that countries with high reserves suffered less during the Global Financial Crisis, and that the effect of reserves is slightly stronger when combined with capital controls.…”