Capital Flows and Capital Controls

Michael W. KleinFletcher School, Tufts University

The Political Economy of International MoneyTower Center for Political Studies, SMUFederal Reserve Bank of Dallas Globalization & Monetary Policy InstituteApril 4, 2014

Keynes’ Views on Capital Mobility

1920 (commenting on the pre-WWI period) “The inhabitant of London could order by

telephone, sipping his morning tea in bed, the various products of the whole earth ... he could at the same moment and by the same means adventure his wealth in the natural resources and new enterprises of any quarter of the world.”

1933 (speech in Dublin)“I sympathize … with those who would minimize

rather than those who would maximize economic entanglements among nations. Ideas, knowledge, art, hospitality, travel – these are things which should of their nature be international. But let goods be home-spun whenever it is reasonable and conveniently possible and, above all, let finance be national.

…and Capital Controls

More Recently

1990s: “Emerging Market Economies” coined Benefits of capital account liberalization

Stan Fischer, January 2003 Ely Lecture to the American Economic Association

“…despite the crises and the arguments of many critics of globalization, almost no country has [shut themselves off from international capital flows]. The revealed preference of the emerging market countries is to stay involved with the international financial system.”

Reversal of Views in Early 2000s

EMEs begin to re-introduce capital controls

Kenneth Rogoff, when serving as Chief Economist and Director of Research of the IMF

“These days, everyone agrees that a more

eclectic approach to capital account liberalization is required.”

Finance and Development, December 2002

In Wake of Crisis: “The Reformation”

• QE2 & EME appreciation, inflow controls • Brazilian finance minister, Guido Mantegna declares

“Currency Wars” in September 2009.• IMF Staff Notes (2010, 2011). Capital Controls as a “Last

resort”– The Economist “The Reformation: A disjointed effort

by the IMF to refine its thinking on capital controls,” April 7, 2011

• Jeanne, Subramanian, Williamson (2012) PIIE “properly designed, they might even be a regular instrument of economic policy.”

What are Capital Controls?• Differential treatment of residents & non-residents.• Administrative

– Outright prohibitions– Reporting requirements – Licensing requirements

• Market-Based– Taxes (e.g. Tobin Tax on forex transactions, Brazil’s IOF tax on

existing equities)– URR (e.g. Chile’s encaje 1992 – 1998).– Thailand (10/2010) re-introduce 15% withholding tax on

interest payments and capital gains on bonds held by foreign investors

Gates vs. Walls“Capital Controls” broad term• Long-Standing / Episodic• Long-standing controls, e.g. China

– Seen as allowing China to keep RMB undervalued• Episodic controls, e.g. Brazil IOF

– Currency Wars, 9/2009 after 30% appreciation in 2009• Walls vs. Gates more apparent now because

trend towards liberalization halted, controls re-imposed

Why Gates ≠ Walls• Gates may be less efficacious than Walls• Gates might not latch shut tightly

– Evasion more likely if investment in surveillance, reporting and enforcement.

• Gates might shut too late– Recognition lag; Implementation lag

• Gates may have rusty hinges: “Punch Bowl”• Benefits of Gates rather than Walls• Procyclical• More narrowly targeted • Gates vs. Bank Regulation: broader, better for countries lacking

regulatory & supervisory frameworks.

Why Gates vs. Walls Matters• Practical discussion on the desirability of capital

controls centers on episodic control– These can be imposed and removed– Theory more supportive of these than of long-

standing• But the evidence on the efficacy of controls (e.g.

weathering the Great Recession) based on experience with long-standing, not episodic.

Capital Controls: 2 Potential Roles

• Trilemma– Scope for Monetary Autonomy

• Prudential: focus on inflow controls – Surges– Asset Price Booms– RER appreciation

11

Exchange Rate Management

MMonetary Policy Independence

Capital Mobility

The Policy Trilemma:Typically considered Tradeoff of B vs. C; avoided choosing A

Δ Own Interest Rate w/ Δ Base Country Interest Rate

Trilemma with Sharp Corners:Systematic Differences Across Regimes

Trilemma Example: US Interest Rate Rises 180 bp, 2004-2005

Trilemma Results with “partial” policies: Klein & Shambaugh 2014

“Rounding the Corners of the Policy Trilemma” Less ← Monetary

Autonomy→ More

Exchange Rate Regime

Peg ≠ Soft Peg ≠ Float

Capital Control Regime

Open = Mid-Open ≠ Closed

Pegs sacrifice autonomy. Gates ineffective, perhaps except for comprehensive

gates. Autonomy: Focus on local conditions rather than base?

From “Capital Controls: Gates vs. Walls,” VOX EU, Jan. 17, 201316

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Capital Inflow Controls and Exchange Rates Around QE2

Gates and the Real Exchange Rate

Conclusion• Distinction between walls and gates• Policy debate over imposition of gates

more relevant for many countries than erecting walls

• Evidence shows that gates, unless broad-based, do not afford monetary autonomy, or insulate an economy from effects from international capital markets.