Capital controls

After the 2008 financial crisis

Capital controls may have externalities. Some empirical studies find that capital flows were diverted to other countries as capital controls were tightened in Brazil. An IMF staff discussion note (Jonathan D. Ostry et al., 2012) explores the multilateral consequences of capital controls, and the desirability of international cooperation to achieve globally efficient outcomes. It flags three issues of potential concern. First is the possibility that capital controls may be used as a substitute for warranted external adjustment, such as when inflow controls are used to sustain an undervalued currency. Second, the imposition of capital controls by one country may deflect some capital towards other recipient countries, exacerbating their inflow problem. Third, policies in source countries (including monetary policy) may exacerbate problems faced by capital-receiving countries if they increase the volume or riskiness of capital flows. The paper posits that if capital controls are justified from a national standpoint (in terms of reducing domestic distortions), then under a range of circumstances they should be pursued even if they give rise to cross-border spillovers. If policies in one country exacerbate existing distortions in other countries, and it is costly for other countries to respond, then multilateral coordination of unilateral policies is likely to be beneficial. Coordination may require borrowers to reduce inflow controls or an agreement with lenders to partially internalize the risks from excessively large or risky outflows.