Capital Controls and Monetary Policy in Developing Countries

April 2010, José Antonio Cordero and Juan Antonio Montecino

This paper looks at both the theoretical and empirical literature on capital controls and finds that capital controls can play an important role in developing countries by helping to insulate them from some of the harmful effects of volatile and short-term capital flows. The authors look at controls on capital inflows in Malaysia (1989-1995); Colombia (1993-1998); Chile (1989-1998); and Brazil (1992-1998), and also consider the case of Malaysia’s controls on outflows in 1998-2001. They conclude that there is sufficient backing in both economic theory and empirical evidence to consider more widespread adoption of capital controls in order to address some of the macroeconomic problems associated with short-term capital flows, to enable certain development strategies, and to allow policy makers more flexibility with regard to crucial monetary and exchange rate policies.

The paper follows what appears to be a shift in the position of the International Monetary Fund (IMF) towards such controls. In a February paper, the IMF concluded that “there may be circumstances in which capital controls are a legitimate component of the policy response to surges in capital inflows.” The Fund’s Global Financial Stability Report released in April 2010 was less sanguine about capital controls, but the net result is that the IMF appears more open to supporting capital controls than in the past.

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