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Capital controls and exchange rate instability in developing economies

  • Reuven Glick
  • Michael Hutchison

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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File URL: http://www.frbsf.org/publications/economics/pbcpapers/2000/pb00-05.pdf
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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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  1. Vittorio Grilli & Gian Milesi-Ferretti, 1995. "Economic Effects and Structural Determinants of Capital Controls," IMF Working Papers 95/31, International Monetary Fund.
  2. Reinhart, Carmen & Kaminsky, Graciela & Lizondo, Saul, 1998. "Leading Indicators of Currency Crises," MPRA Paper 6981, University Library of Munich, Germany.
  3. 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.
  4. 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.
  5. Leonardo Bartolini & Allan Drazen, 1996. "When liberal policies reflect external shocks, what do we learn?," Staff Reports 18, Federal Reserve Bank of New York.
  6. Reuven Glick & Ramon Moreno & Mark M. Spiegel, 2001. "Financial crises in emerging markets," FRBSF Economic Letter, Federal Reserve Bank of San Francisco, issue mar.23.
  7. Hutchison, M. & McDill, K., 1998. "Are All Banking Crises Alike? The Japanese Experience in International Comparison," Papers 99-02, Economisch Institut voor het Midden en Kleinbedrijf-.
  8. 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.
  9. 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.
  10. 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.
  11. Glick, Reuven & Rose, Andrew K., 1999. "Contagion and trade: Why are currency crises regional?," Journal of International Money and Finance, Elsevier, vol. 18(4), pages 603-617, August.
  12. 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.
  13. 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.
  14. James Tobin, 1978. "A Proposal for International Monetary Reform," Cowles Foundation Discussion Papers 506, Cowles Foundation for Research in Economics, Yale University.
  15. Reinhart, Carmen & Edison, Hali, 2001. "Capital controls during financial crises: The case of Malaysia and Thailand," MPRA Paper 13903, University Library of Munich, Germany.
  16. Reinhart, Carmen & Edison, Hali, 2001. "Stopping hot money," MPRA Paper 13862, University Library of Munich, Germany.
  17. Demirguc-Kent, Asli & Detragiache, Enrica, 1998. "Financial liberalization and financial fragility," Policy Research Working Paper Series 1917, The World Bank.
  18. David Romer, 1993. "Openness and Inflation: Theory and Evidence," The Quarterly Journal of Economics, Oxford University Press, vol. 108(4), pages 869-903.
  19. Honohan, Patrick, 2000. "How interest rates changed under financial liberalization - a cross-country review," Policy Research Working Paper Series 2313, The World Bank.
  20. 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.
  21. Glick,Reuven & Moreno,Ramon & Spiegel,Mark M. (ed.), 2001. "Financial Crises in Emerging Markets," Cambridge Books, Cambridge University Press, number 9780521800204, June.
  22. 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.
  23. 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.
  24. Leonardo Bartolini & Allan Drazen, 1996. "Capital Account Liberalization as a Signal," NBER Working Papers 5725, National Bureau of Economic Research, Inc.
  25. Sebastian Edwards, 1999. "Crisis Prevention: Lessons from Mexico and East Asia," NBER Working Papers 7233, National Bureau of Economic Research, Inc.
  26. Vicente Galbis, 1993. "High Real Interest Rates Under Financial Liberalization; Is there a Problem?," IMF Working Papers 93/7, International Monetary Fund.
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