Capital Flows and Capital Controls

1. Capital Flows and Capital Controls Michael W. Klein Fletcher School, Tufts University The Political Economy of International Money Tower Center for Political Studies, SMU Federal Reserve Bank of Dallas Globalization & Monetary Policy Institute April 4, 2014

2. Keynes’ Views on Capital Mobility 1920 (commenting on the pre-WWI period) “The inhabitant of London could order by telephone, sipping his morning tea in bed, the various products of the whole earth ... he could at the same moment and by the same means adventure his wealth in the natural resources and new enterprises of any quarter of the world.”

3. …and Capital Controls 1933 (speech in Dublin) “I sympathize … with those who would minimize rather than those who would maximize economic entanglements among nations. Ideas, knowledge, art, hospitality, travel – these are things which should of their nature be international. But let goods be home-spun whenever it is reasonable and conveniently possible and, above all, let finance be national.

4. More Recently 1990s:“Emerging Market Economies” coined Benefits of capital account liberalization Stan Fischer, January 2003 Ely Lecture to the American Economic Association “…despite the crises and the arguments of many critics of globalization, almost no country has [shut themselves off from international capital flows]. The revealed preference of the emerging market countries is to stay involved with the international financial system.”

5. Reversal of Views in Early 2000s EMEs begin to re-introduce capital controls Kenneth Rogoff, when serving as Chief Economist and Director of Research of the IMF “These days, everyone agrees that a more eclectic approach to capital account liberalization is required.” Finance and Development, December 2002

6. In Wake of Crisis: “The Reformation” • QE2 & EME appreciation, inflow controls • Brazilian finance minister, Guido Mantegna declares “Currency Wars” in September 2009. • IMF Staff Notes (2010, 2011). Capital Controls as a “Last resort” • The Economist “The Reformation: A disjointed effort by the IMF to refine its thinking on capital controls,” April 7, 2011 • Jeanne, Subramanian, Williamson (2012) PIIE “properly designed, they might even be a regular instrument of economic policy.”

7. What are Capital Controls? • Differential treatment of residents & non-residents. • Administrative • Outright prohibitions • Reporting requirements • Licensing requirements • Market-Based • Taxes (e.g. Tobin Tax on forex transactions, Brazil’s IOF tax on existing equities) • URR (e.g. Chile’s encaje1992 – 1998). • Thailand (10/2010) re-introduce 15% withholding tax on interest payments and capital gains on bonds held by foreign investors

8. Gates vs. Walls “Capital Controls” broad term • Long-Standing / Episodic • Long-standing controls, e.g. China • Seen as allowing China to keep RMB undervalued • Episodic controls, e.g. Brazil IOF • Currency Wars, 9/2009 after 30% appreciation in 2009 • Walls vs. Gates more apparent now because trend towards liberalization halted, controls re-imposed

9. Why Gates ≠ Walls • Gates may be less efficacious than Walls • Gates might not latch shut tightly • Evasion more likely if investment in surveillance, reporting and enforcement. • Gates might shut too late • Recognition lag; Implementation lag • Gates may have rusty hinges: “Punch Bowl” • Benefits of Gates rather than Walls • Procyclical • More narrowly targeted • Gates vs. Bank Regulation: broader, better for countries lacking regulatory & supervisory frameworks.

10. Why Gates vs. Walls Matters • Practical discussion on the desirability of capital controls centers on episodic control • These can be imposed and removed • Theory more supportive of these than of long-standing • But the evidence on the efficacy of controls (e.g. weathering the Great Recession) based on experience with long-standing, not episodic.

11. Capital Controls: 2 Potential Roles • Trilemma • Scope for Monetary Autonomy • Prudential: focus on inflow controls • Surges • Asset Price Booms • RER appreciation

12. The Policy Trilemma:Typically considered Tradeoff of B vs. C; avoided choosing A Exchange Rate Management B A M Monetary Policy Independence C Capital Mobility

13. Trilemma with Sharp Corners: Systematic Differences Across Regimes Δ Own Interest Rate w/ Δ Base Country Interest Rate

14. Trilemma Example: US Interest Rate Rises 180 bp, 2004-2005

15. Pegs sacrifice autonomy. • Gates ineffective, perhaps except for comprehensive gates. • Autonomy: Focus on local conditions rather than base?

16. Gates and the Real Exchange Rate From “Capital Controls: Gates vs. Walls,” VOX EU, Jan. 17, 2013

17. Conclusion • Distinction between walls and gates • Policy debate over imposition of gates more relevant for many countries than erecting walls • Evidence shows that gates, unless broad-based, do not afford monetary autonomy, or insulate an economy from effects from international capital markets.