A new literature studies the use of capital controls to prevent financial crises. Within this new framework, we show that when exchange rate policy is costless, there is no need for capital controls. ...However, if exchange rate policy entails efficiency costs, capital controls become part of the optimal policy mix. When exchange rate policy is costly, the optimal mix combines prudential capital controls in tranquil times with policies that limit exchange rate depreciation in crisis times. The optimal mix yields more borrowing, fewer and less severe financial crises, and much higher welfare than with capital controls alone.
•A new literature studies the use of capital controls to prevent financial crises.•We show that if exchange rate policy has no cost, there is no need for capital controls.•If the exchange rate policy is costly, capital controls become part of the optimal policy mix.•This mix combines capital controls in tranquil times with exchange rate policy in crisis times.•It yields more borrowing, fewer and less sever crises, and higher welfare than capital controls alone.
Cryptocurrency markets exhibit periods of large, recurrent arbitrage opportunities across exchanges. These price deviations are much larger across than within countries, and smaller between ...cryptocurrencies, highlighting the importance of capital controls for the movement of arbitrage capital. Price deviations across countries co-move and open up in times of large bitcoin appreciation. Countries with higher bitcoin premia over the US bitcoin price see widening arbitrage deviations when bitcoin appreciates. Finally, we decompose signed volume on each exchange into a common and an idiosyncratic component. The common component explains 80% of bitcoin returns. The idiosyncratic components help explain arbitrage spreads between exchanges.
We empirically assess the effects of China’s capital controls on individual asset categories by using the local projection method. Our results show stark differences among individual asset ...categories. Capital controls on equity and financial credits affect the corresponding net inflows significantly, whereas those on the other three asset categories (bonds, commercial credits, and direct investment) do not.
•We examine the effects of China’s capital controls on individual asset categories.•We use the local projection method.•Our results show stark differences among individual asset categories.•Capital controls on equity and financial credits affect the related net inflows.•However, capital controls on bonds, commercial credits, and direct investment do not.
Capital flows into emerging markets are volatile and risky, which sparked interest in active capital flow management. We first revisit the use of capital controls and discover a new stylized fact: ...emerging markets, which actively revaluate their capital flow restrictions, increase capital inflow controls during episodes of major international financial distress when investors are very risk averse and markets volatile. We then explore this finding theoretically. We argue that heightened international financial volatility and investor risk aversion incentivize regulators to reduce the amount of risky emerging market debt to cope with elevated risk premiums. This rationale can be decentralized via capital inflow restrictions during periods of major financial distress, consistent with the empirical findings. The paper hence provides an alternative to the familiar macroprudential motivation for capital controls.
The global financial cycle has raised concerns about the ability of emerging markets to insulate their economy from international spillovers. Using dynamic Local Projections we show that capital ...controls are as potent as floating exchange rates in dampening the response of international financial shocks on domestic financial variables and the real economy. We relate this finding to muted boom–bust cycles in short-term non-resident capital flows. However, the benefits of floats or capital controls are reaped in isolation, that is, either tool is enough. We attribute this pattern to nominal frictions in domestic labor markets.
Trend shocks and sudden stops Seoane, Hernán D.; Yurdagul, Emircan
Journal of international economics,
November 2019, 2019-11-00, Volume:
121
Journal Article
Peer reviewed
Open access
Sudden Stops are characterized by large output drops, current account reversals and real exchange rate depreciation followed by a slow recovery, a pattern that has proven to be hard to capture with ...standard open economy models. This paper extends the standard models with endogenous collateral constraints to include permanent income (trend) shocks and studies the optimal policy design in this setting. We find that shocks to the trend play an important role in generating a Sudden Stop followed by a slow recovery, a result that is also supported by the data. With trend and transitory shocks, optimal capital control policy is procyclical, although less so than under transitory shocks only.
We use a tractable model to show that emerging markets can protect themselves from the global financial cycle by expanding (rather than restricting) capital flows. This involves accumulating foreign ...liquid assets when global liquidity is high to then buy back domestic assets at a discount when global financial conditions tighten. Since the private sector does not internalize how this buffering mechanism reduces international borrowing costs, a social planner increases the size of capital flows relative to the laissez-faire equilibrium. The model also shows that foreign exchange interventions may be preferable to capital controls in less financially developed countries.
Nonlinearities can arise in international investment factors because of a pecking order in barriers. When direct barriers are severe, improvements in governance factors such as rule of law and ...expropriation risk can increase investment. Only when severe barriers are ameliorated can factors such as firm-specific information, transaction costs and hedging motives become more important. Evidence from unconditional quantile regressions provides support for a pecking order hypothesis, as we find that investment factors vary across the distribution. Specifically, our empirical results indicate that access to basic information is important everywhere, governance and familiarity matter where barriers are high, roles for information and hedging motives become more apparent where barriers are moderate, and where there are no barriers small improvements in governance have little effect on investment. Going forward, analysis should incorporate nonlinearities inherent in cross-border barriers and investment.
Capital controls and firm performance Andreasen, Eugenia; Bauducco, Sofía; Dardati, Evangelina
Journal of international economics,
July 2024, 2024-07-00, Volume:
150
Journal Article
Peer reviewed
Open access
This paper studies the differential effects of capital controls (CCs) on firms’ performance depending on the firm’s production technology and export status. We empirically characterize the firm’s ...responses to the introduction of a CC using the Chilean encaje implemented between 1991 and 1998. Motivated by the empirical insights, we build a general equilibrium model with heterogeneous firms, financial constraints and international trade and calibrate it to the Chilean economy. We find that CCs have heterogeneous effects on firms. Exporting firms operating in more capital-intensive sectors are more negatively affected than exporting firms operating in less capital-intensive sectors. Non-exporting firms in capital-intensive sectors experience more negative effects on capital than firms in less-capital intensive sectors, but the opposite is true for domestic sales. These results are a consequence of the increase in financing costs, the depreciation of the real exchange rate, and compositional effects on the mass of exporters and non-exporters.
We develop a theory of capital controls as dynamic terms-of-trade manipulation. We study an infinite-horizon endowment economy with two countries. One country chooses taxes on international capital ...flows in order to maximize the welfare of its representative agent, while the other country is passive. We show that a country growing faster than the rest of the world has incentives to promote domestic savings by taxing capital inflows or subsidizing capital outflows. Although our theory of capital controls emphasizes interest rate manipulation, the pattern of borrowing and lending, per se, is irrelevant.
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