Capital Controls: Myth and Reality--A Portfolio Balance Approach

This paper is a meta-analysis of the literature on capital controls that aims to solve (at least) four very serious apples-to-oranges problems: (i) There is no unified theoretical framework to analyze the macroeconomic consequences of controls; (ii) there is significant heterogeneity across countries and time in the control measures implemented; (iii) there are multiple definitions of what constitutes a "success"; and (iv) the empirical studies lack a common methodology-furthermore these are significantly over-weighted by a couple of country cases (Chile and Malaysia). In this paper, we attempt to address some of these shortcomings by being very explicit about what measures are construed as capital controls. Also, given that success is measured so differently across studies, we sought to standardize the results of the close to 40 empirical studies we summarize in this paper. The standardization was done by constructing two indices of capital controls: Capital Controls Effectiveness Index (CCE Index), and Weighted Capital Controls Effectiveness Index (WCCE Index). The difference between them lies in that the WCCE controls for the differentiated degree of methodological rigor applied in each of the considered papers. Inasmuch as possible, we bring to bear the experiences of less well-known episodes than those of Chile and Malaysia, and the more recent controls on outflows in emerging Europe. We find that only under countryspecific characteristics are capital controls effective, implying that, more often than not, in practice they do not work. We also show that the equivalence in effects of price vs. quantity capital controls is conditional on the level of short-term capital flows.