In Search of Countercyclical Capital Inflow Controls

Capital controls are often discussed as a potential tool to stabilize macroeconomic fluctuations. However, empirical studies typically find that their use does not systematically respond to the business cycle. This paper revisits the cyclicality of capital inflow controls by considering two possibilities: governments may respond only when output deviations become sufficiently large, and their responses may vary with the underlying macroeconomic policy stance. Using quarterly panel data for 45 advanced and emerging economies from 2000 to 2015, we find that inflow controls are employed countercyclically, but only in response to large output fluctuations. Moreover, the propensity to tighten inflow controls during booms is significantly amplified in countries that pursue more countercyclical fiscal and monetary policies. These findings help reconcile the gap between theoretical expectations and existing empirical findings, suggesting the importance of accounting for threshold effects and macro-policy stance in evaluating capital flow management and incorporating adjustment frictions into theoretical models.