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Ineffective controls on capital inflows under sophisticated financial markets: Brazil in the nineties

We analyze the Brazilian experience in the 1990s to access the effectiveness of controls on capital inflows in restricting financial inflows and changing their composition towards long term flows. Econometric exercises (VARs) lead us to conclude that controls on capital inflows were effective in deterring financial inflows for only a brief period, from two to six months. The hypothesis to explain the ineffectiveness of the controls is that financial institutions performed several operations aimed at avoiding capital controls. We then conducted interviews with market players in order to provide several examples of the financial strategies that were used in this period to invest in the Brazilian fixed income market while bypassing capital controls. The main conclusion is that controls on capital inflows, while they may be desirable, are of very limited effectiveness under sophisticated financial markets. Therefore, policy-makers should avoid spending the scarce resources of bank supervision trying to implement them and focus more in improving economic policy.

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Paper provided by Department of Economics PUC-Rio (Brazil) in its series Textos para discussão with number 516.

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Length: 43 pages
Date of creation: Mar 2006
Date of revision:
Publication status: Published in National Bureau of Economic Research Working Paper no. 12283, 2006
Handle: RePEc:rio:texdis:516
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  1. Leonardo Bartolini & Allan Drazen, 1996. "When liberal policies reflect external shocks, what do we learn?," Staff Reports 18, Federal Reserve Bank of New York.
  2. Reinhart, Carmen M. & Smith, R. Todd, 2002. "Temporary controls on capital inflows," Journal of International Economics, Elsevier, vol. 57(2), pages 327-351, August.
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  11. Kristin J. Forbes, 2004. "Capital Controls: Mud in the Wheels of Market Discipline," NBER Working Papers 10284, National Bureau of Economic Research, Inc.
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  26. Corbo, Vittorio & Hernandez, Leonardo, 1996. "Macroeconomic Adjustment to Capital Inflows: Lessons from Recent Latin American and East Asian Experience," World Bank Research Observer, World Bank Group, vol. 11(1), pages 61-85, February.
  27. Michael Gavin & Ricardo Hausmann & Leonardo Leiderman, 1995. "Macroeconomics of Capital Flows to Latin America: Experience and Policy Issues," Research Department Publications 4012, Inter-American Development Bank, Research Department.
  28. Christopher J. Neely, 1999. "An introduction to capital controls," Review, Federal Reserve Bank of St. Louis, issue Nov, pages 13-30.
  29. Vicente Galbis, 1996. "Currency Convertibility and the Fund; Review and Prognosis," IMF Working Papers 96/39, International Monetary Fund.
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