Literature Survey on Capital Controls

Capital Flows is the biggest problem facing emerging market economies. It is leading to the Central Banks of these economies managing the impossible trinity. As neither monetary policy nor exchange rate management wished to be left to market forces, managing the capital flows looks like the best bet. I have pointed to how some of the Emerging European countries have been doing it here.

There have been numerous papers on the topic. What has been the broad evidence. Here is an informative paper from Magun and Reinhart which is a literature survey of the various papers on the subject. The papers selected are not theoretical but of experiences of various countries w.r.t capital controls.

They have developed an index tracking the evidence in various papers weighing based on the rigor used in the various papers. It is like this:

1) They have assembled various country specific case studies/papers on capital controls
2) They have analysed the impact of capital controls on 4 parameters:

(i) Reduce the volume of capital flows?
(ii) Alter the composition of capital flows (towards longer maturity flows)?
(iii) Reduce real exchange rate pressures?
(iv) Allow for a more independent monetary policy?

3) Every study would have its own methodology to arrive at the results. They develop an index which answers whether capital controls helped achieve any of the objectives

4) They also develop a seperate index weighted on the basis of econometrics rigor based on the subject.

The findings are:

For Capital Controls on inflows:

  • Malaysia (1994) stands out as the best performance in terms of reducing the volume of capital flows,
  • Chile dominates regarding the change in capital flows maturity,
  • Thailand does it in respect to reducing real exchange rate pressures, and
  • Chile also dominates in regards to monetary policy independence.
    Overall, as the average of the WCCE Index reflects, Chile emerges as the more successful example of capital controls on inflows.

For controls on Capital outflows:

  • Thailand and Spain at reducing capital flows

  • Regarding the switch in capital flows towards more longer maturity no conclusion can be extracted,

  • Spain emerges as the best in regard to real exchange rate pressures reduction;

  • Malaysia clearly dominates when dealing with making monetary policy more independent.

  • On the aggregate, Malaysia appears as the more successful experience in terms of capital controls on outflows.

A neat paper. It also points to the emerging idea of development economics- every country is different and hence impact capital controls differs across countries.

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