Working Paper: NBER ID: w26447
Authors: Bilge Erten; Anton Korinek; José Antonio Ocampo
Abstract: This paper synthesizes recent advances in the theoretical and empirical literature on capital controls. We start by observing that international capital flows have both benefits and costs, but some of these are not internalized by individual actors and thus constitute externalities. The theoretical literature has identified pecuniary externalities and aggregate demand externalities that respectively contribute to financial instability and recessions. These externalities provide a natural rationale for counter-cyclical capital controls that lean against boom and busts cycles in international capital flows. The empirical literature has developed several measures of capital controls to capture different aspects of capital account openness. We evaluate the strengths and weaknesses of different measures and provide an overview of the empirical findings on the effectiveness of capital controls in addressing the externalities identified by the theory literature, i.e. in reducing financial fragility and enhancing macroeconomic stability. We also discuss strategies to deal with the endogeneity of capital controls in such statistical exercises. We conclude by providing an overview of the historical and current debates on the role of capital controls in macroeconomic management and their relationship to the academic literature.
Keywords: capital controls; financial stability; macroeconomic management; externalities; emerging markets
JEL Codes: D62; E44; F32; F38; H23
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| capital controls (F38) | reduced financial fragility (F65) |
| capital controls (F38) | stabilize aggregate demand (E00) |
| economic overheating (E31) | reduced financial fragility (F65) |
| capital controls (F38) | financial stability (G28) |
| capital controls (F38) | macroeconomic stability (E60) |