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The illusive quest: Do international capital controls contribute to currency stability?

  • Glick, Reuven
  • Hutchison, Michael

We investigate the effectiveness of capital controls in insulating economies from currency crises, focusing in particular on both direct and indirect effects of capital controls and how these relationships may have changed over time in response to global financial liberalization and the greater mobility of international capital. We predict the likelihood of currency crises using standard macroeconomic variables and a probit equation estimation methodology with random effects. We employ a comprehensive panel data set comprised of 69 emerging market and developing economies over 1975-2004. Both standard and duration-adjusted measures of capital control intensity (allowing controls to "depreciate" over time) suggest that capital controls have not effectively insulated economies from currency crises at any time during our sample period. Maintaining real GDP growth and limiting real overvaluation are critical factors preventing currency crises, not capital controls. However, the presence of capital controls greatly increases the sensitivity of currency crises to changes in real GDP growth and real exchange rate overvaluation, making countries more vulnerable to changes in fundamentals. Our model suggests that emerging markets weathered the 2007-2008 crisis relatively well because of strong output growth and exchange rate flexibility that limited overvaluation of their currencies.

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Article provided by Elsevier in its journal International Review of Economics & Finance.

Volume (Year): 20 (2011)
Issue (Month): 1 (January)
Pages: 59-70

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Handle: RePEc:eee:reveco:v:20:y:2011:i:1:p:59-70
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/620165

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  2. Reinhart, Carmen & Kaminsky, Graciela & Lizondo, Saul, 1998. "Leading Indicators of Currency Crises," MPRA Paper 6981, University Library of Munich, Germany.
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  4. Edwards, Sebastian, 2007. "Capital controls, capital flow contractions, and macroeconomic vulnerability," Journal of International Money and Finance, Elsevier, vol. 26(5), pages 814-840, September.
  5. Reinhart, Carmen & Edison, Hali, 2001. "Stopping hot money," MPRA Paper 13862, University Library of Munich, Germany.
  6. Jonathan David Ostry & Atish R. Ghosh & Karl Friedrich Habermeier & Marcos Chamon & Mahvash Qureshi & Dennis B. S. Reinhardt, 2010. "Capital Inflows; The Role of Controls," IMF Staff Position Notes 2010/04, International Monetary Fund.
  7. Barry Eichengreen & Poonam Gupta & Ashoka Mody, 2006. "Sudden Stops and IMF-Supported Programs," NBER Working Papers 12235, National Bureau of Economic Research, Inc.
  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. Reuven Glick & Xueyan Guo & Michael Hutchison, 2006. "Currency Crises, Capital-Account Liberalization, and Selection Bias," The Review of Economics and Statistics, MIT Press, vol. 88(4), pages 698-714, November.
  10. 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.
  11. Sebastian Edwards, 2007. "Capital Controls, Sudden Stops, and Current Account Reversals," NBER Chapters, in: Capital Controls and Capital Flows in Emerging Economies: Policies, Practices and Consequences, pages 73-120 National Bureau of Economic Research, Inc.
  12. Frankel, Jeffrey A. & Rose, Andrew K., 1996. "Currency crashes in emerging markets: An empirical treatment," Journal of International Economics, Elsevier, vol. 41(3-4), pages 351-366, November.
  13. Leonardo Bartolini & Allan Drazen, 1996. "When liberal policies reflect external shocks, what do we learn?," Staff Reports 18, Federal Reserve Bank of New York.
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  17. James Tobin, 1978. "A Proposal for International Monetary Reform," Eastern Economic Journal, Eastern Economic Association, vol. 4(3-4), pages 153-159, Jul/Oct.
  18. Torsten Sloek & Michael Klein & Luca Antonio Ricci & Hali J. Edison, 2002. "Capital Account Liberalization and Economic Performance; Survey and Synthesis," IMF Working Papers 02/120, International Monetary Fund.
  19. Daniel Gros, 1987. "The Effectiveness of Capital Controls: Implications for Monetary Autonomy in the Presence of Incomplete Market Separation," IMF Staff Papers, Palgrave Macmillan, vol. 34(4), pages 621-642, December.
  20. Ayhan Kose & Kenneth Rogoff & Eswar Prasad & Shang-Jin Wei, 2003. "Effects of Financial Globalization on Developing Countries; Some Empirical Evidence," IMF Occasional Papers 220, International Monetary Fund.
  21. Chinn, Menzie David & Ito, Hiro, 2005. "What Matters for Financial Development? Capital Controls, Institutions, and Interactions," Santa Cruz Department of Economics, Working Paper Series qt5pv1j341, Department of Economics, UC Santa Cruz.
  22. 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.
  23. Binici, Mahir & Hutchison, Michael & Schindler, Martin, 2010. "Controlling capital? Legal restrictions and the asset composition of international financial flows," Journal of International Money and Finance, Elsevier, vol. 29(4), pages 666-684, June.
  24. Reuven Glick & Michael Hutchison, 2002. "Capital controls and exchange rate instability in developing economies," Pacific Basin Working Paper Series 2000-05, Federal Reserve Bank of San Francisco.
  25. 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.
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