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Capital controls and exchange rate instability in developing economies

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  • Reuven Glick
  • Michael Hutchison

Abstract

A large literature on the appropriate sequencing of financial liberalization suggests that removing capital controls prematurely may contribute to currency instability. This paper investigates whether legal restrictions on international capital flows are associated with greater currency stability. We employ a comprehensive panel data set of 69 developing economies over the 1975–1997 period, identifying 160 currency crises. We control for macroeconomic, political, and institutional characteristics that influence the probability of a currency crisis, employ alternative measures of restrictions on international payments, and account for possible joint causality between the likelihood of a currency attack and the imposition of capital controls. We find evidence that restrictions on capital flows do not effectively insulate economies from currency problems; rather, countries with less restrictive capital controls and more liberalized regimes appear to be less prone to speculative attacks.

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Bibliographic Info

Paper provided by Federal Reserve Bank of San Francisco in its series Pacific Basin Working Paper Series with number 2000-05.

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Date of creation: 2002
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Publication status: Published in Journal of International Money and Finance, V. 24, no. 3 (April 2005) pp. 387-412
Handle: RePEc:fip:fedfpb:2000-05

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Keywords: Foreign exchange rates ; Developing countries ; Monetary policy;

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  1. Leonardo Bartolini & Allan Drazen, 1996. "Capital Account Liberalization as a Signal," NBER Working Papers 5725, National Bureau of Economic Research, Inc.
  2. David Romer, 1991. "Openness and inflation: theory and evidence," Proceedings, Federal Reserve Bank of San Francisco, issue Nov.
  3. Michael Hutchison & Kathleen McDill, 1999. "Are All Banking Crises Alike? The Japanese Experience in International Comparison," NBER Working Papers 7253, National Bureau of Economic Research, Inc.
  4. Reuven Glick & Ramon Moreno & Mark Spiegel, 2001. "Financial crises in emerging markets," FRBSF Economic Letter, Federal Reserve Bank of San Francisco, issue mar.23.
  5. Graciela Laura Kaminsky, 1997. "Leading Indicators of Currency Crises," IMF Working Papers 97/79, International Monetary Fund.
  6. Reuven Glick & Andrew K. Rose, 1998. "Contagion and Trade: Why Are Currency Crises Regional?," NBER Working Papers 6806, National Bureau of Economic Research, Inc.
  7. Reinhart, Carmen & Edison, Hali, 2001. "Stopping hot money," MPRA Paper 13862, University Library of Munich, Germany.
  8. Barry Eichengreen & Charles Wyplosz, 1993. "The Unstable EMS," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 24(1), pages 51-144.
  9. James Tobin, 1978. "A Proposal for International Monetary Reform," Eastern Economic Journal, Eastern Economic Association, vol. 4(3-4), pages 153-159, Jul/Oct.
  10. Leonardo Bartolini & Allan Drazen, 1996. "When Liberal Policies Reflect External Shocks, What Do We Learn?," NBER Working Papers 5727, National Bureau of Economic Research, Inc.
  11. Demirguc-Kent, Asli & Detragiache, Enrica, 1998. "Financial liberalization and financial fragility," Policy Research Working Paper Series 1917, The World Bank.
  12. Honohan, Patrick, 2000. "How interest rates changed under financial liberalization - a cross-country review," Policy Research Working Paper Series 2313, The World Bank.
  13. Barry Eichengreen & Andrew K. Rose, 1998. "Staying Afloat When the Wind Shifts: External Factors and Emerging-Market Banking Crises," NBER Working Papers 6370, National Bureau of Economic Research, Inc.
  14. Vicente Galbis, 1993. "High Real Interest Rates Under Financial Liberalization," IMF Working Papers 93/7, International Monetary Fund.
  15. Vittorio Grilli & Gian-Maria Milesi-Ferretti, 1995. "Economic Effects and Structural Determinants of Capital Controls," IMF Working Papers 95/31, International Monetary Fund.
  16. Carmen M. Reinhart & Graciela L. Kaminsky, 1999. "The Twin Crises: The Causes of Banking and Balance-of-Payments Problems," American Economic Review, American Economic Association, vol. 89(3), pages 473-500, June.
  17. Giancarlo Corsetti & Paolo Pesenti & Nouriel Roubini, 1998. "Paper Tigers? A Model of the Asian Crisis," NBER Working Papers 6783, National Bureau of Economic Research, Inc.
  18. Michael P. Dooley, 1996. "A Survey of Literature on Controls over International Capital Transactions," IMF Staff Papers, Palgrave Macmillan, vol. 43(4), pages 639-687, December.
  19. Hali J. Edison & Michael W. Klein & Luca Ricci & Torsten Sloek, 2002. "Capital Account Liberalization and Economic Performance: Survey and Synthesis," NBER Working Papers 9100, National Bureau of Economic Research, Inc.
  20. Jeffrey A. Frankel & Andrew K. Rose, 1996. "Currency crashes in emerging markets: an empirical treatment," International Finance Discussion Papers 534, Board of Governors of the Federal Reserve System (U.S.).
  21. Hali J. Edison & Carmen M. Reinhart, 1999. "Capital controls during financial crises: the cases of Malaysia and Thailand," Proceedings, Federal Reserve Bank of San Francisco, issue Sep.
  22. Barry J. Eichengreen, 1999. "Toward a New International Financial Architecture: A Practical Post-Asia Agenda," Peterson Institute Press: All Books, Peterson Institute for International Economics, number 51.
  23. Dooley, Michael P & Isard, Peter, 1980. "Capital Controls, Political Risk, and Deviations from Interest-Rate Parity," Journal of Political Economy, University of Chicago Press, vol. 88(2), pages 370-84, April.
  24. De Gregorio, Jose & Edwards, Sebastian & Valdes, Rodrigo O., 2000. "Controls on capital inflows: do they work?," Journal of Development Economics, Elsevier, vol. 63(1), pages 59-83, October.
  25. Sebastian Edwards, 1999. "Crisis Prevention: Lessons from Mexico and East Asia," NBER Working Papers 7233, National Bureau of Economic Research, Inc.
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