Journal Issue

Research Summaries: Capital Controls

International Monetary Fund. Research Dept.
Published Date:
November 2001
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Natalia Tamirisa

The importance of capital flows to the operation of the international financial system has increased dramatically during recent decades. In particular, capital inflows have helped many developing economies to grow rapidly, but have also exacerbated the risks associated with existing distortions and weaknesses and have exposed some of these economies to financial crises triggered by sudden reversals of capital inflows. The use of controls to manage trade in assets, the effectiveness of capital controls, and their overall macroeconomic implications have been subjects of intense debate in both policy and academic circles. IMF staff have contributed extensively to the economic literature on capital controls; this survey focuses on the most recent of these contributions.

Capital controls prevailed during much of the twentieth century. By limiting capital outflows, controls were used to facilitate the financing of the two world wars. Controls were also seen as a means to achieve greater monetary policy independence during the Great Depression and to support the functioning of the Bretton Woods system of fixed exchange rates.

Beginning in the 1970s, the developed countries gradually phased out capital controls and, in the 1990s, even the developing countries started to liberalize their capital accounts. This trend reflected a growing acceptance that capital controls (with the exception of prudential ones) tend to be inefficient and costly. Controls are also hard to sustain when domestic financial transactions are liberalized, and they run counter to the aims of a macroeconomic management framework that is designed to work through market forces. The easing of capital controls, along with the revolutions in information and communication technologies, led to a dramatic increase in international capital flows in the 1990s.1

Capital flows provide substantial benefits to individual countries and the international economy as a whole, but these benefits may not be fully realized if serious imperfections exist in capital markets (Eichengreen and others, 1998).2 These imperfections have never been more obvious than during financial crises in emerging markets in the late 1990s, when questions about the role of capital controls were once again brought to the forefront of policy debates.

Capital control regulations are multifaceted, and quantifying them for comparisons across countries and over time is a challenge. Most studies have relied on the use of dummy variables from the IMF’s Annual Report on Exchange Arrangements and Exchange Restrictions (following Grilli and Milesi-Ferretti, 1995).3 Using new and more disaggregated information in this report, Johnston and others (1999) construct indices that take into account the diversity of capital controls.4 Edison and Warnock (forthcoming) propose a new measure of the intensity of capital controls for emerging market economies—the ratio of the market capitalizations underlying a country’s International Financial Corporation Investable and Global indices (IFCI and IFCG).5

Countries set up capital controls for a variety of reasons. Controls are often associated with fixed or managed exchange rate regimes, lower per capita incomes, larger shares of government consumption in GDP, less independent central banks, and larger current account deficits (Alesina, Grilli and Milesi-Ferretti, 1994; Grilli and Milesi-Ferretti, 1995).6 Generally, different types of controls serve different purposes. Macroeconomic reasons appear to motivate controls on capital inflows, balance of payments management usually motivates controls on capital outflows, while institutional and market structures typically motivate financial regulations related to the operation of banks and institutional investors (Johnston and Tamirisa, 1998).7

Evidence on the effectiveness of capital controls is mixed. Country experiences suggest that capital controls may be useful in dealing with volatile capital flows and may provide some “breathing room” for implementing economic reforms, but they are difficult to administer and cannot substitute for proper macroeconomic policies (Ariyoshi and others, 2000; Ishii, Ötker-Robe, and Cui, 2001).8 Not surprisingly, more effective controls tend to be more distortionary as well.

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IMF Staff Papers, the IMF’s scholarly journal, edited by Robert Flood, publishes selected high-quality research produced by IMF staff and invited guests on a variety of topics of interest to a broad audience, including academics and policymakers in IMF member countries. The papers selected for publication in the journal are subject to a rigorous review process using both internal and external referees. The journal and its contents (including an archive of articles from past issues) are available online at the Research at the IMF website at

Temporary controls on capital inflows, for example, appear to be effective only when they are highly punitive, and may even lower welfare if the government procrastinates in removing them (Smith and Reinhart, 2001).9 The effectiveness of Chile’s encaje (a one-year, mandatory reserve requirement which was imposed on selective, mostly short-term capital inflows during 1991-98) also appears to have been limited. A review of empirical studies on the topic by Nadal-De Simone and Sorsa (1999) concludes that, while there is some evidence that the encaje increased interest rates and altered the composition of capital inflows, it had only a temporary impact in reducing specific inflows.10

With regard to the use of controls on outflows in times of financial crises, Edison and Reinhart (forthcoming) conclude that only in Malaysia in 1998 did controls lead to greater interest rate and exchange rate stability and more policy autonomy. This was not the case in Brazil in 1999 or in Thailand in 1997, possibly owing to differences in leakage and arbitrage opportunities and in the types of controls.11 Controls on bank operations and on foreign exchange and equity market transactions appear to have been particularly effective in Malaysia in terms of their impact on capital flows (Meesook and others, 2001).12

The macroeconomic effects of capital controls remain a subject of intensive research. Alesina, Grilli, and Milesi-Ferretti (1994) and Grilli and Milesi-Ferretti (1995) find that countries imposing controls tend to have higher inflation rates but lower real interest rates. Such countries apparently enjoy a smaller output loss for a given reduction in the inflation rate (Loungani, Razin, and Yuen, 2000).13 It has also been shown that capital controls can reduce the informational efficiency of financial markets (Habermeier and Kirilenko, 2001) as well as hinder trade (Tamirisa, 1999).14 Controls also appear to be important in affecting financial fragility and economic performance (Rossi, 1999).15 A recent study for the IMF’s World Economic Outlook estimates that the liberalization of capital controls is likely to promote investment and financial development and could thus increase growth by half a percent a year or more.16

Removing capital controls, when macroeconomic policies and the financial system have not been adapted appropriately, raises a risk of external or financial sector instability. Capital account liberalization therefore needs to be coordinated with other policies, and should take into account a country’s macroeconomic position, the development of its financial system, and the effectiveness of existing controls (Ishii and others, forthcoming).17 While there are no simple rules for sequencing, country experiences point to some general principles and methodological approaches. Fundamentally, the removal of capital controls appears to be an important step on the path to development, and no country can isolate itself from the market (at least for very long) without hurting its economic prospects. The challenge is to manage risks in crossborder capital movements, and sound macroeconomic and prudential policies are crucial in this regard.18

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Full-text versions (or, in some cases, detailed summaries) of books published by the IMF are available online at the Research at the IMF website at Follow the link to IMF Publications.

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Detailed contents of IMF Occasional Papers are available at the Research at the IMF website at

The increased role of capital flows to the operation of the international monetary system has led to discussions about extending IMF jurisdiction to cover capital movements. See Stanley Fischer, Richard N. Cooper, Rudiger Dornbusch, Peter M. Garber, Carlos Massad, Jacques J. Polak, Dani Rodrik, and Savak S. Tarpore, “Should the IMF Pursue Capital-Account Convertibility?” Essays in International Finance, 1998 (Princeton, NJ: Princeton University).

Barry Eichengreen, Michael Mussa, Giovanni Dell’Ariccia, Enrica Detragiache, Gian Maria Milesi-Ferretti, and Andrew Tweedie, Capital Account Liberalization: Theoretical and Practical Aspects, IMF Occasional Paper No. 172, 1998. Also see Michael P. Dooley, “A Survey of the Literature on Controls over International Capital Transactions,” IMF Staff Papers (December 1996).

Vittorio Grilli and Gian Maria Milesi-Ferretti, “Economic Effects and Structural Determinants of Capital Controls,” IMF Staff Papers (September 1995).

R. Barry Johnston, Mark Swinburne, Alexander Kyei, Bernard Laurens, David Mitchem, Inci Ötker, Susana Sosa, and Natalia Tamirisa, Exchange Rate Arrangements and Currency Convertibility: Developments and Issues, World Economic and Financial Surveys, Chapter 7, 1999. For a summary description of the indices, see Natalia Tamirisa, “Exchange and Capital Controls as Barriers to Trade,” IMF Staff Papers (March 1999).

Hali J. Edison and Francis E. Warnock, “A Simple Measure of the Intensity of Capital Controls,” forthcoming IMF Working Paper.

Alberto Alesina, Vittorio Grilli, and Gian Maria Milesi-Ferretti, “The Political Economy of Capital Controls,” in Capital Mobility: The Impact on Consumption, Investment and Growth, L. Leiderman and A. Razin, 1994 (Cambridge, UK: Cambridge University Press).

R. Barry Johnston and Natalia Tamirisa, “Why Do Countries Use Capital Controls?” IMF Working Paper 98/181, 1998.

Akira Ariyoshi, Karl Habermeier, Bernard Laurens, Inci Ötker-Robe, Jorge Ivan Canales-Kriljenko, and Andrei Kirilenko, Capital Controls: Country Experiences with Their Use and Liberalization, IMF Occasional Paper No. 190, 2000; and Shogo Ishii, Inci Ötker-Robe, and Li Cui, “Measures to Limit the Offshore Use of Currency,” IMF Working Paper 01/43, 2001. Also see Pedro Alba, Leonardo Hernandez, and Daniela Klingebiel, “Financial Liberalization and the Capital Account: Thailand 1988-97,” in The Political Economy of the East Asian Crisis and Its Aftermath, ed. by Arvid J. Lukauskas and Francisco L. Rivera-Batiz, 2001 (Cheltenham, UK and Northampton, USA: Edward Elgar).

R. Todd Smith and Carmen M. Reinhart, “Temporary Controls on Capital Inflows,” NBER Working Paper No. 8422, 2001, also forthcoming in Journal of International Economics.

Francisco Nadal-De Simone and Piritta Sorsa, “A Review of Capital Account Restrictions in Chile in the 1990s,” IMF Working Paper 99/52, 1999. Also see Francisco Gallego, Leonardo Hernandez, and Klaus Schmidt-Hebbel, “Capital Controls in Chile: Were They Effective?” in Banking, Financial Integration, and International Crises, ed. by Leonardo Hernandez and Klaus Schmidt-Hebbel (Santiago, Chile: Central Bank of Chile, forthcoming).

Hali J. Edison and Carmen M. Reinhart, “Stopping Hot Money,” forthcoming in Journal of Development Economics.

Kanitta Meesook, Il Houng Lee, Olin Liu, Yougesh Khatri, Natalia Tamirisa, Michael Moore, and Mark Krysl, “Malaysia: From Crisis to Recovery,” IMF Occasional Paper No. 207, 2001.

Prakash Loungani, Assaf Razin, and Chi-Wa Yuen, “Capital Mobility and Output-Inflation Trade-Off,” IMF Working Paper 00/87, 2000, forthcoming in Journal of Development Economics.

Karl Habermeier and Andrei Kirilenko, “Securities Transaction Taxes and Financial Markets,” IMF Working Paper 01/51, 2001.

Marco Rossi, “Financial Fragility and Economic Performance in Developing Economies: Do Capital Controls, Prudential Regulation and Supervision Matter?” IMF Working Paper 99/66, 1999. For an analysis of consumption smoothing in the presence of capital controls, see Luiz R. de Mello, Jr. and Khaled A. Hussein, “International Capital Mobility in Developing Countries: Theory and Evidence,” Journal of International Money and Finance (June 1999); and Tim Callen and Paul Cashin, “Assessing External Sustainability in India,” IMF Working Paper 99/181, 1999, forthcoming in Journal of International Trade and Economic Development.

”International Financial Integration and Developing Countries,” World Economic Outlook, October 2001, World Economic and Financial Surveys, Chapter 4, 2001. This finding refers to a measure of capital account openness based on gross holdings of international assets and liabilities. Also see Nicola Fuchs-Schundeln and Norbert Funke, “Stock Market Liberalizations: Financial and Macroeconomic Implications,” forthcoming IMF Working Paper.

Shogo Ishii, Karl Habermeier, Bernard Laurens, John Leimone, Judit Vadasz, Jorge Ivan Canales-Kriljenko, “Capital Account Liberalization and Financial Sector Stability,” forthcoming IMF Occasional Paper. Also see Leslie Lipschitz, Tim Lane, and Alex Mourmouras, “Capital Flows to Transition Economies: Master or Servant,” forthcoming IMF Working Paper. On how capital controls link with trade, see Byung K. Jang, “Capital Controls and Trade Liberalization in a Monetary Economy,” IMF Working Paper 99/24, 1999; and Natalia Tamirisa, Piritta Sorsa, Bradley McDonald, Geoffrey Bannister, and Jaroslaw Wieczorek, “Trade Policy in Financial Services,” IMF Working Paper 00/31, 2000, also published in International Economic Policy Review, 2000.

R. Barry Johnston and Inci Ötker-Robe, “A Modernized Approach to Managing the Risks in Cross-Border Capital Movements,” IMF Policy Discussion Paper 99/06, 1999.

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