Working Paper: CEPR ID: DP9706
Authors: Fridrik Mar Baldursson; Richard Portes
Abstract: We examine Iceland?s capital controls, which were imposed in October 2008 in order to prevent massive capital flight and a complete collapse of the exchange rate. The controls have not been lifted yet, primarily because of the risk of outflows of domestic holdings of the failed cross-border Icelandic banks. A substantial restructuring of domestic holdings of foreign creditors of the old banks is required before capital controls can be lifted. We argue that even if the controls are damaging, the gains from lifting them are likely to be much lower than the costs associated with a potential currency crisis following a premature liberalisation of capital outflows. The case of Iceland illustrates the difficulty of resolving large cross-border banks situated in a small currency area.
Keywords: Capital Controls; Cross-Border Banking; Icelandic Banks; Resolution of Failed Banks
JEL Codes: E58; F31; G21
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Imposition of capital controls in October 2008 (F38) | Prevention of massive capital flight (F32) |
| Imposition of capital controls in October 2008 (F38) | Stabilization of the exchange rate of the Icelandic króna (F31) |
| Lifting capital controls prematurely (F32) | Potential for a currency crisis (F31) |
| Restructuring of domestic holdings of foreign creditors (F34) | Mitigation of risks associated with capital outflows (F32) |
| Timing of lifting controls (C41) | Economic stability (E60) |