Working Paper: NBER ID: w12852
Authors: Sebastian Edwards
Abstract: In this paper I analyze whether restrictions to capital mobility reduce vulnerability to external shocks. More specifically, I ask if countries that restrict the free flow of international capital have a lower probability of experiencing a large contraction in net capital flows. I use three new indexes on the degree of international financial integration and a large multi-country data set for 1970-2004 to estimate a series of random-effect probit equations. I find that the marginal effect of higher capital mobility on the probability of a capital flow contraction is positive and statistically significant, but very small. Having a flexible exchange rate greatly reduces the probability of experiencing a capital flow contraction. The benefits of flexible rates increase as the degree of capital mobility increases. A higher current account deficit increases the probability of a capital flow contraction, while a higher ratio of FDI to GDP reduces that probability.
Keywords: capital controls; capital flow contractions; macroeconomic vulnerability; international financial integration
JEL Codes: F3; F32; F34
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| higher capital mobility (F20) | higher probability of experiencing a capital flow contraction (CFC) (F32) |
| flexible exchange rate regime (F33) | lower probability of experiencing a capital flow contraction (CFC) (F32) |
| higher current account deficit (F32) | higher probability of experiencing a capital flow contraction (CFC) (F32) |
| higher ratio of foreign direct investment (FDI) to GDP (F21) | lower probability of experiencing a capital flow contraction (CFC) (F32) |