Domestic and Multilateral Effects of Capital Controls in Emerging Markets

Using a novel dataset on changes in capital controls and currency-based prudential measures in 17 major emerging market economies (EMEs) over the period 2001-2011, this paper provides new evidence on domestic and spillover effects of capital controls before and after the global financial crisis. Our results, based on panel VARs on quarterly data, suggest that capital control actions do not allow countries to avoid the trade-offs of the monetary policy trilemma. Where they have a desired impact on the trilemma variables – net capital inflows, monetary policy autonomy and the exchange rate – the size of that impact is generally small. While we find some evidence of effectiveness before the global financial crisis, the usefulness of these measures weakened in the post-crisis environment of abundant global liquidity and relatively strong economic growth in EMEs. Our results also show that capital control policies can have unintended consequences, as resident outflows offset the impact of capital control actions on gross inflows (or vice versa). These findings highlight the importance of the macroeconomic context and of the increasing role of resident flows in understanding the effectiveness of capital inflow management. Using panel near-VARs, we find significant spillovers of capital control actions in BRICS (Brazil, Russia, India, China and South Africa) to other EMEs during the 2000s. Spillover effects were more important in the aftermath of the global financial crisis than before the crisis, and arose from inflow tightening actions, rather than outflow easing measures. The channels through which these policies spilled over to other countries were exchange rates as well as capital flows (especially cross-border bank lending). Spillovers seem to be more prevalent in Latin America than in Asia, reflecting the greater role of cross-border banking and more open capital accounts in the former countries. These results are robust to various specifications of our models.