Are capital controls applied the way they are supposed to be?

It seems the answer is no, they are applied acyclically rather than pro-cyclically to calm down overheating economies.  Here is a new paper by Andrés FernándezAlessandro Rebucci, and Martín Uribe, “Are Capital Controls Prudential? An Empirical Investigation”:

A growing recent theoretical literature advocates the use of prudential capital control policy, that is, the tightening of restrictions on cross-border capital flows during booms and the relaxation thereof during recessions. We examine the behavior of capital controls in a large number of countries over the period 1995-2011. We find that capital controls are remarkably acyclical. Boom-bust episodes in output, the current account, or the real exchange rate are associated with virtually no movements in capital controls. These results are robust to decomposing boom-bust episodes along a number of dimensions, including the level of development, the level of external indebtedness, or the exchange-rate regime. We also document a near complete acyclicality of capital controls during the Great Contraction of 2007-2009.

This relates to what is perhaps the most frequent mistake in economic analysis.  Markets “as we find them” are compared to government policy “as it ought to be,” rather than “government policy as we find it.”  If you had nothing else to do, you could blog that error hundreds of times a day.

You also might wish to sample this 2011 IMF survey on capital controls, which relates the following: “A review of the literature shows that capital  controls (as distinct from prudential CFMs) have little effect on overall flows, although it appears that controls can change the composition of flows. In most cases, controls also have little effect on currency appreciation…A broader review of the experiences of 13 emerging market economies in the 2000s also does not provide unambiguous support for the effectiveness of capital controls and prudential measures.”

Wishing don’t make it so.


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