The Role of Capital Controls

Ugo Panizza
November 18, 2010


Boom and bust cycles of capital flows to emerging market countries have been a permanent feature of the international monetary system since the early era of financial globalization (Eichengreen, 2008). Talks of “currency wars” and concerns about the potential disruptive effects of the recent surge of capital flows to emerging markets have again put capital account management (the politically correct term for capital controls) at the center of the policy debate.

Countries receiving large capital inflows have three policy options: (i) do nothing; (ii) intervene in the foreign exchange market; (iii) impose capital controls.  Each of these choices implies difficult trade-offs. Countries that decide to do nothing may end up with an overvalued currency which, in turn, could lead to low growth and a currency crisis down the road. Countries that decide to conduct sterilized interventions may be able to prevent a nominal and real appreciation (unsterilized intervention can only prevent a nominal appreciation) but could end up paying a large fiscal cost. Countries that decide to impose controls on inflows can, in some instances, limit appreciation while preserving their ability of conducting an independent monetary policy. Capital controls, however, can promote rent-seeking activities and introduce distortion on the economy.    

Calvo (2010) suggests that controls on capital inflows are likely to be ineffective and distractive. A recent IMF Staff Position Note (Ostry et al, 2010) suggests that capital controls on inflows can be useful under somewhat stringent conditions (they are only desirable for countries that have an overvalued exchange rate, inflationary concerns, cannot accumulate reserves, cannot sterilize, cannot tighten fiscal policy, and have weak prudential regulation).  Various UN agencies (e.g., UNCTAD, 1998), instead, deem capital controls to be a useful instrument in a much broader set of countries and also support the use of controls on outflows.

The policy debate on capital controls is closely related to the academic literature on the growth effects of financial globalization and financial liberalization.  Henry (2007) claims that there is strong evidence that capital account liberalization has a positive effect on GDP growth.  Rancière et al. (2008) argue that financial liberalization increases both volatility and growth. Kose et al. (2006) suggest that, for the average country, financial globalization has no significant effect on GDP growth but that financial globalization can be good for countries with good macroeconomic and regulatory policies. Finally, Rodrik and Subramanian (2009) suggest that there is no evidence that financial globalization is good for growth and argue that there are several cases in which financial globalization could hurt economic growth.



1. What should countries that receive large amounts of inflows do? Should they welcome them, should they learn to live with them, or should they try to limit them?

2. Is good regulation of the domestic banking system a substitute for capital controls?

3. If large and volatile inflows are indeed a problem, would a global solution be preferable to the current system? And if so, what should this solution be?

4. What are the costs and benefits of financial globalization? Should we think about the issue in the same way we think about speed limits or is there no trade-off involved?

5. What practices work best in capital account management? Are there good and bad capital controls? Are controls on outflows acceptable and, if so, under what conditions?