Capital Control

Capital Control

Capital controls are residency-based measures such as transaction taxes and other limits or outright prohibitions, which a nation's government can use to regulate flows from capital markets into and out of the country's capital account. These measures may be economy-wide, sector-specific (usually the financial sector), or industry specific (for example, “strategic” industries). They may apply to all flows, or may differentiate by type or duration of the flow (debt, equity, direct investment; short-term vs. medium- and long-term).

Types of capital control include exchange controls that prevent or limit the buying and selling of a national currency at the market rate, caps on the allowed volume for the international sale or purchase of various financial assets, transaction taxes such as the proposed Tobin tax, minimum stay requirements, requirements for mandatory approval, or even limits on the amount of money a private citizen is allowed to remove from the country. There have been several shifts of opinion on whether capital controls are beneficial and in what circumstances they should be used.

Capital controls were an integral part of the Bretton Woods system which emerged after World War II and lasted until the early 1970s. This period was the first time capital controls had been endorsed by mainstream economics. In the 1970s free market economists became increasingly successful in persuading their colleagues that capital controls were in the main harmful. The US, other western governments, and the international financial institutions (the International Monetary Fund (IMF) and World Bank) began to take an increasingly critical view of capital controls and persuaded many countries to abandon them to reap the benefits of financial globalization.

The Latin American debt crisis of the early 1980s, the East Asian Financial Crisis of the late 1990s, the Russian Ruble crisis of 1998-99, and the Global Financial Crisis of 2008, however, highlighted the risks associated with the volatility of capital flows, and led many countries—even those with relatively open capital accounts—to make use of capital controls alongside macroeconomic and prudential policies as means to dampen the effects of volatile flows on their economies.

In the aftermath of the Global Financial Crisis, as capital inflows surged to emerging market economies, a group of economists at the IMF outlined the elements of a policy toolkit to manage the macroeconomic and financial-stability risks associated with capital flow volatility, and the role of capital controls within that toolkit. The study, as well as a successor study focusing on financial-stability concerns stemming from capital flow volatility, while not representing an IMF official view, were nevertheless influential in generating debate among policy makers and the international community, and ultimately in bringing about a shift in the institutional position of the IMF. With the increased use of capital controls in recent years, the IMF has moved to destigmatize the use of capital controls alongside macroeconomic and prudential policies to deal with capital flow volatility. More widespread use of the capital controls instrument, however, raises a host of multilateral coordination issues, as enunciated for example by the G-20, echoing the concerns voiced by Keynes and White more than six decades ago.

Read more about Capital Control:  Free Movement of Capital and Payments

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