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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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References

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  1. Jose De Gregorio & Sebastian Edwards & Rodrigo O. Valdes, 2000. "Controls on Capital Inflows: Do they Work?," NBER Working Papers 7645, National Bureau of Economic Research, Inc.
  2. Hali J. Edison & Michael W. Klein & Luca Antonio Ricci & Torsten Sløk, 2004. "Capital Account Liberalization and Economic Performance: Survey and Synthesis," IMF Staff Papers, Palgrave Macmillan, vol. 51(2), pages 2.
  3. Corsetti, Giancarlo & Pesenti, Paolo & Roubini, Nouriel, 1999. "Paper tigers?: A model of the Asian crisis," European Economic Review, Elsevier, vol. 43(7), pages 1211-1236, June.
  4. Leonardo Bartolini & Allan Drazen, 1996. "When liberal policies reflect external shocks, what do we learn?," Staff Reports 18, Federal Reserve Bank of New York.
  5. Graciela Laura Kaminsky, 1997. "Leading Indicators of Currency Crises," IMF Working Papers 97/79, International Monetary Fund.
  6. David Romer, 1991. "Openness and Inflation: Theory and Evidence," NBER Working Papers 3936, National Bureau of Economic Research, Inc.
  7. Eichengreen, Barry & Rose, Andrew K, 1998. "Staying Afloat When the Wind Shifts: External Factors and Emerging-Market Banking Crises," CEPR Discussion Papers 1828, C.E.P.R. Discussion Papers.
  8. 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.
  9. Demirguc-Kent, Asli & Detragiache, Enrica, 1998. "Financial liberalization and financial fragility," Policy Research Working Paper Series 1917, The World Bank.
  10. 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.
  11. Leonardo Bartolini & Allan Drazen, 1997. "Capital Account Liberalization as a Signal," NBER Working Papers 5725, National Bureau of Economic Research, Inc.
  12. Reinhart, Carmen & Edison, Hali, 2001. "Stopping hot money," MPRA Paper 13862, University Library of Munich, Germany.
  13. Hutchison, Michael & McDill, Kathleen, 1999. "Are All Banking Crises Alike? The Japanese Experience in International Comparison," Journal of the Japanese and International Economies, Elsevier, vol. 13(3), pages 155-180, September.
  14. Reuven Glick & Andrew K. Rose, 1998. "Contagion and trade: why are currency crises regional?," Pacific Basin Working Paper Series 98-03, Federal Reserve Bank of San Francisco.
  15. Vittorio Grilli & Gian Maria Milesi-Ferretti, 1995. "Economic Effects and Structural Determinants of Capital Controls," IMF Staff Papers, Palgrave Macmillan, vol. 42(3), pages 517-551, September.
  16. 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.
  17. Sebastian Edwards, 1999. "Crisis Prevention: Lessons from Mexico and East Asia," NBER Working Papers 7233, National Bureau of Economic Research, Inc.
  18. Reuven Glick & Ramon Moreno & Mark Spiegel, 2001. "Financial crises in emerging markets," FRBSF Economic Letter, Federal Reserve Bank of San Francisco, issue mar.23.
  19. 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.
  20. James Tobin, 1978. "A Proposal for International Monetary Reform," Eastern Economic Journal, Eastern Economic Association, vol. 4(3-4), pages 153-159, Jul/Oct.
  21. 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.
  22. 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.).
  23. Honohan, Patrick, 2000. "How interest rates changed under financial liberalization - a cross-country review," Policy Research Working Paper Series 2313, The World Bank.
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