Capital Control - History - Post Washington Consensus: 2009 and Later

Post Washington Consensus: 2009 and Later

By 2009, the global financial crisis had caused a resurgence in Keynesian thought which reversed the previously prevailing orthodoxy. During the 2008–2012 Icelandic financial crisis, the IMF proposed that capital controls on outflows should be imposed by Iceland, calling them "an essential feature of the monetary policy framework, given the scale of potential capital outflows."

In the latter half of 2009, as the global economy started to recover from the Global Financial Crisis, capital inflows to emerging market economies—especially, in Asia and Latin America—surged, raising macroeconomic and financial-stability risks. Several emerging market economies responded to these concerns by adopting capital controls or macroprudential measures; for example, Brazil imposed a tax on the purchase of financial assets by foreigners and Taiwan restricted overseas investors from buying Time deposits.

The partial return to favor of capital controls is linked to a wider emerging consensus among policy makers for the greater use of macroprudential policy. According to economics journalist Paul Mason, international agreement for the global adoption of Macro prudential policy was reached at the 2009 G-20 Pittsburgh summit - an agreement which Mason said had seemed impossible at the London summit which took place only a few months before.

Pro capital control statements by various prominent economists, together with an influential staff position note prepared by IMF economists in February 2010 (Jonathan D. Ostry et al., 2010), and a follow-up note prepared in April 2011, have been hailed as an "end of an era" that eventually led to a change in the IMF's long held position that capital controls should be used only in extremis, as a last resort, and on a temporary basis.

In June 2010 The Financial Times published several articles on the growing trend towards using capital controls. They noted influential voices from the Asian Development Bank and World Bank had joined the IMF in advising there is a role for capital controls. The FT reported on the recent tightening of controls in Indonesia, South Korea, Taiwan, Brazil and Russia. In Indonesia recently implemented controls include a one-month minimum holding period for certain securities. In South Korea limits have been placed on currency forward positions. In Taiwan the access that foreigner investors have to certain bank deposits has been restricted. The FT cautioned that imposing controls has a downside including the creation of possible future problems in attracting funds.

By September 2010, emerging economies had experienced huge capital inflows resulting from carry trades made attractive to market participants by the expansionary monetary policies several large economies had undertook over the previous two years as a response to the crisis. This has led to countries such as Brazil, Mexico, Peru, Colombia, Korea, Taiwan, South Africa, Russia and Poland further reviewing the possibility of increasing their capital controls as a response. In October, with reference to increased concern about capital flows and widespread talk of an imminent Currency war, financier George Soros has suggested that capital controls are going to become much more widely used over the next few years. But several analysts have questioned whether controls will be effective for most countries, with Chile's finance minister saying his country had no plans to use them.

In February 2011, citing evidence from new IMF research (Ostry et al., 2010) that restricting short-term capital inflows could lower financial-stability risks, over 250 economists headed by Joseph Stiglitz wrote a letter to the Obama administration asking them to remove clauses from various bilateral trade agreements that allow the use of capital controls to be penalized. There was strong counter lobbying by business and so far the US administration has not acted on the call, although some figures such as Treasury secretary Tim Geithner have spoken out in support of capital controls at least in certain circumstances.

Econometric analyses undertaken by the IMF, and other academic economists found that in general countries which deployed capital controls weathered the 2008 crisis better than comparable countries which did not. In April 2011 the IMF published its first ever set of guidelines for the use of capital controls. At November's 2011 G-20 Cannes summit, the G20 agreed that developing countries should have even greater freedom to use capital controls than the IMF guidelines allow. A few weeks later the Bank of England published a paper where they broadly welcomed the G20's decision in favor of even greater use of capital controls, though they caution that compared to developing countries, advanced economies may find it harder to implement efficient controls. Not all momentum has been in favor of increased use of capital controls however. For example, in December 2011 China partially loosened its controls on inbound capital flows, which the Financial Times described as reflecting an ongoing desire by Chinese authorities for further liberalization. India also lifted some of its controls on inbound capital in early January 2012, drawing criticism from economist Arvind Subramanian who considers relaxing capital controls a good policy for China but not for India considering her different economic circumstances.

In September 2012, Michael W. Klein of Tufts University challenged the emergent consensus that short term capital controls can be beneficial, publishing a preliminary study that found the measures used by countries like Brazil had been ineffective (at least up to 2010). Klein argues it was only countries with long term capital controls, such as China and India, that have enjoyed measurable protection from adverse capital flows. In the same month, Ila Patnaik and Ajay Shah of NIPFP published an article about the permanent and comprehensive capital controls in India, which seem to have been ineffective in achieving the goals of macroeconomic policy. However, other studies have found that capital controls may lower financial stability risks, while the controls Brazilian authorities adopted after the 2008 financial crisis did have some beneficial effect on Brazil itself.

Yet capital controls may have externalities: some empirical studies find that capital flows were diverted to other countries as capital controls were tightened in Brazil. An IMF staff discussion note explores the multilateral consequences of capital controls, and the desirability of international cooperation to achieve globally efficient outcomes. It flags three issues of potential concern. First is the possibility that capital controls may be used as a substitute for warranted external adjustment (for example, when inflow controls are used to sustain an undervalued currency). Second, the imposition of capital controls by one country may deflect some capital towards other recipient countries, exacerbating their inflow problem. Third, policies in source countries (including monetary policy) may exacerbate problems faced by capital-receiving countries if they increase the volume or riskiness of capital flows. The paper argues however that if capital controls are justified from a national standpoint (in terms of reducing domestic distortions), then under a range of circumstances they should be pursued even if they give rise to cross-border spillovers. But if policies in one country exacerbate existing distortions in other countries, and it is costly for other countries to respond, then multilateral coordination of unilateral policies is likely to be beneficial. Coordination may require borrowers to reduce inflow controls or an agreement with lenders to partially internalize the risks from excessively large or risky outflows.

On December 3rd, the IMF published a staff paper which further expanded on their recent support for the limited use of capital controls.