This paper examines capital controls from a long-term perspective, it analyzes theoretically and empirically their determinants and their economic effects. With regard to the determinants of capital controls, the paper investigates whether certain political and structural features of an economy make the imposition or removal of capital controls more likely. With regard to the effects of foreign exchange restrictions, it investigates whether limitations on capital mobility, together with other economic, political, and institutional features, help explain the behavior of key macroeconomic variables, such as inflation, real interest rates, and growth.
The theoretical part of the paper presents a simple and widely used overlapping generations model. Although no formal test of propositions derived from the model is performed, the theoretical framework helps to identify some of the key issues examined in the empirical analysis. The empirical part of the paper is based on a panel of 61 developing and developed countries. Dummy variables are constructed from the IMF’s Annual Report on Exchange Arrangements and Exchange Restrictions as proxies for capital controls. These proxies include restrictions on payments for current and capital account transactions and multiple currency practices.
Several interesting empirical regularities are identified in the paper. Capital controls are more likely to be in place when income is low, the share of government in economic activity is large, the exchange rate is managed, and the government has a relatively free hand in monetary policy because the central bank is not very independent. As for the economic impact of capital controls, restrictions on capital account transactions tend to be associated with higher inflation, a higher share of seigniorage revenue in total revenue, and lower interest rates. This study finds no robust impact of capital controls on the rate of growth, although there is evidence that countries with large black-market premiums (themselves correlated with foreign exchange restrictions) grow more slowly.