The Information Content of Capital Controls

Capital controls, policy measures used by governments to regulate cross-country financial flows, have become standard policy options in many emerging market economies. This paper will focus on what capital controls reveal about the state of the economy and the implications of such revelation for policy efficacy. Using a small open economy model with a collateral constraint and overborrowing relative to the social optimum, this paper incorporates a representative agent's Bayesian updating of information in response to change in policy and show that the efficacy of capital controls to contain financial crises and improve welfare could be undermined if the agent rationally learns from policy. Empirically, this paper finds that capital controls convey important information market participants use to improve their understanding of fundamentals. This paper highlights the need for policymakers to consider the unintended consequences of information revelation in the design of capital flow management policies.