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Are Capital Controls in the Foreign Exchange Market Effective?

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  • Straetmans, Stefan
  • Versteeg, Roald
  • Wolff, Christian C

Abstract

One of the reasons for governments to use capital controls is to obtain some degree of monetary independence. This paper investigates the link between capital controls and interest differentials/ forward premia. This to test whether they can indeed give governments the power to drive exchange rates away from parity conditions. Two capital control variables are constructed in addition to the standard IMF capital control dummy. These variables are used to determine the date of capital account liberalization in a panel of Western European as well as emerging countries. Results show that capital controls do not give governments extra monetary freedom. There is even some evidence that capital controls decrease the level of monetary freedom governments enjoy for a number of countries.

Suggested Citation

  • Straetmans, Stefan & Versteeg, Roald & Wolff, Christian C, 2008. "Are Capital Controls in the Foreign Exchange Market Effective?," CEPR Discussion Papers 6727, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:6727
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    3. Jinjarak, Yothin & Noy, Ilan & Zheng, Huanhuan, 2013. "Capital controls in Brazil – Stemming a tide with a signal?," Journal of Banking & Finance, Elsevier, vol. 37(8), pages 2938-2952.
    4. Wan, Xiaoli & Yan, Yuruo & Zeng, Zhixiong, 2020. "Exchange rate regimes and market integration: evidence from the dynamic relations between renminbi onshore and offshore markets," The North American Journal of Economics and Finance, Elsevier, vol. 52(C).
    5. Cardarelli, Roberto & Elekdag, Selim & Kose, M. Ayhan, 2010. "Capital inflows: Macroeconomic implications and policy responses," Economic Systems, Elsevier, vol. 34(4), pages 333-356, December.
    6. Bank for International Settlements, 2015. "Cross-border financial linkages - challenges for monetary policy and financial stability," BIS Papers, Bank for International Settlements, number 82, June.
    7. Ibrahim D. Raheem & Xuan Vinh Vo, 2022. "A new approach to exchange rate forecast: The role of global financial cycle and time‐varying parameters," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 27(3), pages 2836-2848, July.
    8. Bruno, Valentina & Shim, Ilhyock & Shin, Hyun Song, 2017. "Comparative assessment of macroprudential policies," Journal of Financial Stability, Elsevier, vol. 28(C), pages 183-202.
    9. Simeon Nanovsky & Yoonbai Kim, 2018. "International Capital Movement and Monetary Independence in Asia," International Advances in Economic Research, Springer;International Atlantic Economic Society, vol. 24(2), pages 179-198, May.

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    More about this item

    Keywords

    Capital controls; Exchange Rates; Forward premia; Interest differentials; Monetary freedom;
    All these keywords.

    JEL classification:

    • E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Sytsems; Standards; Regimes; Government and the Monetary System
    • F21 - International Economics - - International Factor Movements and International Business - - - International Investment; Long-Term Capital Movements
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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