are capital controls effective in preventing financial crisesa

Are Capital Controls Effective in Preventing Financial Crises?

Ling Huang

School of Economics, the Peking University and

Stanford Center for International Development

February 26, 2013

Fundamental questions: Capital controls Feb 18th 2010 The Economist

The IMF changes its mind on controls on capital inflows

演示者

演示文稿备注

Under the skin of any international economist lies a deep-seated belief in some variant of the PPP theory of exchange rates."�� - Rudiger Dornbusch & Paul Krugman (1976 The years since the onset of the Great Financial Crises has seen a remarkable comeback of capital control practices in a number of emerging markets who are facing upward pressure on their currencies by surge in capital inflows. The more eye-catching event is that, starting in 2010, some of the IMF economists suggest capital controls be part of the usual policy toolkits for countries to safeguard their financial system. Now a paper* by a group of IMF economists suggests that the fund has substantially rethought its position on the use of restrictions by emerging markets on capital inflows. It concludes that controls are sometimes “justified as part of the policy toolkit” for an economy seeking to deal with surging inflows. This is surprising. The fund has historically opposed capital controls, even trying in 1997 to amend its articles of agreement to allow it explicitly to promote capital- account liberalisation. Its economists have argued both that capital controls are costly because they induce distortions to resource allocation and that they are not effective because they are easily evaded. In this paper, we study a sample of 118 developing countries over 1970-2009 to answer this question: after controlling the usual suspects for currency crises, does a higher degree of capital control lead to a lower probability of currency crises?

Fundamental questions: Capital controls

• On April 5th 2011 the IMF released two documents designed to achieve just that … But several curious differences between them suggest that the fund’s own thinking on managing capital flows is far from settled.

• Jeanne, Subramanian and Williamson (2012) argue that capital control should not be a last resort, rather “…properly designed they might even be a regular instrument of economic policy.”

• Klein (2012)：“ With a few exceptions, there is little evidence of the efficacy of capital controls on the growth of financial variables, the real exchange rate, or GDP growth at an annual frequency. These preliminary results raise doubts about assumptions behind recent calls for a greater use of episodic controls on capital inflows”

• Brazil, Iceland, Ireland, Peru and Turkey introduced new controls on capital inflows recently.

演示者

演示文稿备注

. In February 2010 a research paper by a team of economists at the fund led by Jonathan Ostry cautiously endorsed the use of controls in situations where a country facing a capital surge had a currency that was appropriately valued, had already built up enough reserves and had no further room to tighten fiscal policy. The fund now reckons these conditions are not all that rare. It finds that 9 out of 39 emerging markets studied would have been justified, as of late 2010, in resorting to such controls because they had exhausted other options.

Key Points • data sample : 118 emerging market and developing

countries; time frame： 1970-2009 • Most currency crash events occurred in tight capital

control settings; • Loosening capital control is linked to reduced

likelihood of currency crises after controlling the relevant macroeconomic and financial variables.

• Preliminary evidence of discipline effect of capital account openness: in general, the tighter the capital control, the weaker the macroeconomic fundamentals.

演示者

演示文稿备注

As the subprime crisis escalates, people increasingly cast skepticism on the merits of international financial integration and call for suitable capital controls to stem financial crises. These empirical facts could help us evaluate the costs and benefits of capital control objectively and hence set the right pace of financial liberalization.

Outline

• Key question： Upon controlling the usual macroeconomic and financial

correlates of currency crises, how does a higher degree of capital account openness marginally affect the likelihood of currency crises?

Outline • Structure :

– Literature review

– Identifying the currency crash events

– Univariate analysis: the behavior of the control variables in the antecedent (T-3: T) and aftermath (T+1:T+3) of the currency crash events – are they statistically different from the control group observations (“tranquil periods”)

– Multivariate analysis: Probit estimation

– Further empirical work to explain the Probit regression results.

Correlates of Currency Crises • We select the following correlates of currency crises suggested by the

literature : – (1) reserves adequacy variables: M2/international reserves, ratio

of short-term debt to international reserves – (2) Policy indicators: domestic credit growth, domestic credit to

private sector, M2 growth rate, budget balance (% of GDP), government consumption growth rate

– (3) Internal variables: inflation rate, real interest rate, investment growth, consumption growth, real growth rate

– (4) External variables: overvaluation, current account, export growth

– (5) External debt variables: total debt(% of GDP), short-term debt(% if total debt), short-term debt/export ratio, short-term debt (% of GDP), ratio of equity liabilities to debt liabilities

Index of de jure Financial Openness

The Chinn-Ito de jure index of financial openness kchin

variable min p25 p50 p75 max sd ------------------------------------------------------------------------------------- kchin -1.808 -1.129 -0.086 1.497 2.541 1.552

The Chinn-Ito Rating Index is constructed out of the natural break of the Chinn-Ito de jure index of capital control:

kchinr = 1, 2, 3, 4, 5

1 2 3 4 5 close open

演示者

演示文稿备注

kchinr=1 corresponds to the lowest degree of openness, and 5 the highest. KAOPEN is based on the binary dummy variables that codify the tabulation of restrictions on cross-border financial transactions reported in the IMF's Annual Report on Exchange Arrangements and Exchange Restrictions (AREAER) http://web.pdx.edu/~ito/Chinn-Ito_website.htm

Distribution of Countries under Different Degree of Financial Openness

• 118 emerging and developing countries, Year 2007

Number of countries under each level of kchinr

kchinr=1 kchinr=2 kchinr=3 kchinr=4 kchinr=5

Upper income group

0 5 5 11 19

Middle income group

3 15 7 6 7

Low income group 4 24 2 3 5

Indexes of de facto Financial Openness (International Financial Integration)

• Data source: Lane and Milesi-Ferretti’s "External Wealth of Nations" Dataset 1970-2007 and calculation based on the IMF IFS dataset • GFA: gross foreign assets

• GFL: gross foreign liabilities

• Indexes: • IFI1=100*(GFA+GFL)/PPPGDP

• IFI2=100*(GFA+GFL)/GDP

• IFI3=100*(GFA+GFL)/TRADE

-1.00

-0.50

0.00

0.50

1.00

1.50

1970 1975 1980 1985 1990 1995 2000 2005 20101A. Chinn-Ito Index

0

100

200

300

400

1970 1975 1980 1985 1990 1995 2000 2005 20101B. IFI2=100*(GFA+GFL)/GDP

0

100

200

300

1970 1975 1980 1985 1990 1995 2000 2005 20101C. IFI1=100*(GFA+GFL)/PPPGDP

50

100

150

200

250

300

1970 1975 1980 1985 1990 1995 2000 2005 20101D. IFI3=100*(GFA+GFL)/TRADE

Average Trend of International Financial IntegrationUpper income group Middle income group Low income group

Identifying “Currency Crash” Events

• Criterions for indentifying “currency crash” events ( a la Frankel and Rose 1996):

– Annual devaluation rate at least 25% – Devaluation rate is at least 10% higher than in the previous

year. – Events occurring within 3 years of an earlier event are

windowed out.

• 197 independent currency crash events are identified – Reduced to 175 events if we count the group devaluations by

the 13 CFA countries in 1981 or 1994 as a single event. – The magnitude of the devaluations rates for these events: median 59%; 25th percentile 37%; 75th 110%

演示者

演示文稿备注

Aftershock Currency crash events are not identical as currency crises events. Ideally, we shall design an exchange rate market pressure index to capture all those episodes when countries sell off their foreign reserves or strike an interest rate hike to fight off the speculative attacks. CFA franc zone Theacronym CFA stands for Communauté Financière d'Afrique ("Financial Community of Africa") or Communauté Financière Africaine ("African Financial Community"

6

2

3 3

1

5

3

1

8

6

8 8

6

5

7

5

2

10

9

6 6

10

5

3

6

11

7

2 2

6

5

1 1

7

1970 1974 1978 1982 1986 1990 1994 1998 2002 2006Year

The Frequency of Currency Crash Events in LDCs

46

64

25

11

6

1 2 3 4 5The Chinn-Ito Rating Index of Financial Openess

Distribution of Crises across de jure openness

演示者

演示文稿备注

This is a first evidence

0

10

20

30

40

50

10 20 30 40 50 60 70 80 90%

M2/Intl reserves minus gold

0

2

4

6

8

10

10 20 30 40 50 60 70 80 90%

Short-term debt/intl reserves

Behavior of indicators during the crises episodesPercentile curves

T-3:T T+1:T+3 control group

演示者

演示文稿备注

First order stochastic dominance

0

50

100

150

10 20 30 40 50 60 70 80 90%

Domestic credit growth

0

50

100

10 20 30 40 50 60 70 80 90%

Domestic credit to private sector growth

0

50

100

10 20 30 40 50 60 70 80 90%

M2 growth rate

-6

-4

-2

0

2

4

10 20 30 40 50 60 70 80 90%

budget balance(%GDP)


0

50

100

150

10 20 30 40 50 60 70 80 90%

Inflation rate

10

15

20

25

30

35

10 20 30 40 50 60 70 80 90%

Investment rate

-5

0

5

10

10 20 30 40 50 60 70 80 90%

GDP growth

-15

-10

-5

0

5

10 20 30 40 50 60 70 80 90%

Current account(%GDP)


0

10

20

30

40

50

10 20 30 40 50 60 70 80 90%

Ratio of debt liabilities to equity liabilities

0

50

100

150

10 20 30 40 50 60 70 80 90%

External debt(%GDP)

0

5

10

15

20

10 20 30 40 50 60 70 80 90%

Short-term debt(%GDP)

0

20

40

60

80

100

10 20 30 40 50 60 70 80 90%

Short-term debt(%Export)


Nonparametric Tests: (T-3:T) vs. Control Group

Variables Kruskal-Wallis

Kolmogorov-Smirnov t-test

M2/intl reserves 0 0 0.054

Short debt/intl reserves 0 0 0.009

Domestic credit growth 0 0 0.828

DC to private sector growth 0 0 0

DC to private sector/M2 0 0 0.002

Bank loans(% GDP) 0.392 0.312 0.82

M2 growth 0 0 0

Budget balance(% GDP) 0.001 0.011 0.005

Government debt(% GDP) 0.132 0.048 0.028

Inflation 0 0 0

Investment(% GDP) 0 0 0

Investment growth 0 0 0

Variables Kruskal-Wallis

Kolmogorov-Smirnov t-test

Consumption growth 0 0 0

GDP growth 0 0 0

Current account(%GDP) 0 0 0

Export growth 0 0 0

openness 0 0 0 de facto International Financial Integration1 0 0 0

de facto International Financial Integration2 0 0 0

Total debt(%GDP) 0 0 0

Short-term debt(%GDP) 0 0 0

Short-term debt/export & income 0 0 0

Short-term debt(% export) 0 0 0

Debt/equity ratio 0 0 0.079

Probit Estimates

• The model:

– K -- Chinn-Ito index

– X -- control variables

– In order to avoid the endogeneity problem and to smooth out the short-run fluctuations of the variables, we use averages of the T-3, T-2, T-1 values for all the regressors.

β)X KΘ(1)sProb(crisi iitit +== α

(1) (3) (5) (7) (10)VARIABLES ev ev ev ev ev

kchinl -0.0141** -0.0143** -0.0157*** -0.0144** -0.0114**(-2.525) (-2.503) (-2.649) (-2.520) (-2.064)

ifidl -0.000203** -0.000245** -0.000246** -0.000240**(-2.091) (-2.268) (-2.362) (-2.488)

imresl 0.000149** 0.000153** 0.000149**(1.984) (2.010) (1.981)

dc3gl 6.56e-06 -6.83e-06 -1.85e-05*(0.612) (-0.588) (-1.703)

drerl -0.000482** -0.000515** -0.000622** -0.000509** -0.000544**(-2.165) (-2.085) (-2.528) (-2.054) (-2.148)

sdx1l 0.000248*** 0.000220*** 0.000246*** 0.000240***(3.521) (3.406) (3.509) (3.534)

ygl -0.00687*** -0.00653*** -0.00669*** -0.00657*** -0.00595***(-3.962) (-3.615) (-3.646) (-3.602) (-3.347)

cayl -0.00256** -0.00213** -0.00173* -0.00214** -0.00122(-2.414) (-1.961) (-1.741) (-1.975) (-1.105)

sdrl 0.000145**(2.072)

ifipl -0.000234(-1.327)

dcpv3gl -6.33e-06(-0.671)

m2gl 5.90e-06(0.348)

gresml -0.00646**(-2.338)

dertol

gvcgl

sdxl

sdtdl

Observations 1779 1735 1728 1734 1745Pseudo R-squared 0.0626 0.0741 0.0692 0.0742 0.0767Robust z-statistics *** p<0.01, ** p<0.0

kchinl ifidl sdrl dc3gl drerl ygl cayl-0.018 -0.021 0.008 0.003 -0.015 -0.024 -0.015

kchinl ifidl imresl dcpv3gl drerl sdx1l ygl cayl -0.018 -0.026 0.008 -0.003 -0.016 0.016 -0.023 -0.013

Marginal effect on the likelihood if the regressor goes up by one standard deviation

• Given that all other regressors are evaluated at the mean, the likelihood that a country encounters a crisis will drop to 0.032 from 0.089 if it moves from the lowest degree of capital account openness to highest degree of openness.

– Marginal effects after dprobit – y = Pr(ev) (predict, p) – = .03225865

– Marginal effects after dprobit – y = Pr(ev) (predict, p) – = .0894081

• Finding: currency crash events are more likely to occur

under a setting of tighter capital controls.

• Why?

• “Core” and “Peripheral” research themes in the literature

“The Costs and Effects of Capital Controls – A Review of Recent Literature and Implications for China” (working paper, Huang 2012)

– Core: Does financial openness promote higher economic growth?

– Peripherals:

1. Are capital controls effective in preventing large volumes of capital inflows or outflows?

2. Will capital controls bring about monetary autonomy for the countries who aims to stabilize their exchange rates?

3. Do capital controls bring about distortion and corruption to the economy?

演示者

演示文稿备注

Let me digress for a moment The past decade has seen a rapid growth of the literature on normative and positive analysis of capital controls. Surrounding the classical research topic of “does capital openness help promote economic growth?”, several research themes are sprouting and growing, featuring detailed studies on the various potential costs and effects of capital controls as well as the potential risks and benefits of capital openness. This paper gives a review of these developments. 上世纪七十年代，McKinnon(1973)和Shaw(1973)开启了金融压抑对经济增长的危害的讨论。九十年代亚洲金融危机的爆发使亚洲经济奇迹走向幻灭，Rodrik(1998)发出了究竟“谁需要资本账户的可兑换性？”的疑问，并引发了最近一波关于资本开放与经济增长的关系的研究热潮。 Despite an abundance of cross-section, panel, and event studies, there is strikingly little convincing documentation of direct positive impacts of financial opening on the economic welfare levels or growth rates of developing countries. The econometric difficulties are similar to those that bedevil the literature on trade openness and growth, though if anything, they are more severe in the context of finance. There is also little systematic evidence that financial opening raises welfare indirectly by promoting collateral reforms of economic institutions or policies. At the same time, opening the financial account does appear to raise the frequency and severity of economic crises. Nonetheless, developing countries have moved over time in the direction of further financial openness.

• “Core” and “Peripheral” research themes in the literature – Core: Does financial openness promote higher

economic growth?

– Peripherals:

4. Will capital account liberalization promote the development of domestic financial system?

5. Does financial openness possess “discipline effects”– to discipline and motivate the governments to pursue macro-prudential and sustainable policies?

6. Are capital controls effective in preventing financial crises? Or do capital controls help the economies to fare better in the aftermath of the financial crises?

演示者

演示文稿备注

Let me digress for a moment The past decade has seen a rapid growth of the literature on normative and positive analysis of capital controls. Surrounding the classical research topic of “does capital openness help promote economic growth?”, several research themes are sprouting and growing, featuring detailed studies on the various potential costs and effects of capital controls as well as the potential risks and benefits of capital openness. This paper gives a review of these developments. 上世纪七十年代，McKinnon(1973)和Shaw(1973)开启了金融压抑对经济增长的危害的讨论。九十年代亚洲金融危机的爆发使亚洲经济奇迹走向幻灭，Rodrik(1998)发出了究竟“谁需要资本账户的可兑换性？”的疑问，并引发了最近一波关于资本开放与经济增长的关系的研究热潮。 Despite an abundance of cross-section, panel, and event studies, there is strikingly little convincing documentation of direct positive impacts of financial opening on the economic welfare levels or growth rates of developing countries. The econometric difficulties are similar to those that bedevil the literature on trade openness and growth, though if anything, they are more severe in the context of finance. There is also little systematic evidence that financial opening raises welfare indirectly by promoting collateral reforms of economic institutions or policies. At the same time, opening the financial account does appear to raise the frequency and severity of economic crises. Nonetheless, developing countries have moved over time in the direction of further financial openness.

Why capital control is linked to higher odds of currency crises?

• Theoretical arguments against capital controls: – From microeconomic perspective: capital control can

cause distortion and facilitate corruption with the cost of reduced efficiency and resource mis-allocation, resulting in lower productivity and growth potential.

• Rajan and Zingales (1998) • Johnson and Mitton (2002), Desai et. al. (2002), Forbes (2003)

– From macroeconomic perspective, financial openness may possess a “discipline effect”. Therefore, policy makers may be subject to adverse selection or moral hazard problems when deciding capital account policies.

• Obstfeld (1998)，Tytell and Wei (2005)

演示者

演示文稿备注

Rodrick从微观角度分析，资本管制有着显著的经济成本，将导致资源配置的低效和错配，降低生产效率和增长潜力，并且容易滋生扭曲和腐败。这些后果会滋长经济不稳定因素，成为危机的诱因之一。Rajan and Zingales (1998) 认为在相对封闭的资本市场环境中，政府、银行与关系企业之间的资金运作纽带才较易维持，而关系贷款必然导致坏账率上升和产生各种扭曲的激励，因此资本管制是滋生裙带资本主义的温床从宏观层面看来，Obstfeld (1998)，Tytell and Wei (2005)等都提出金融开放具有“纪律效应”（“discipline effect”）：政府的良治、健康的宏观经济环境、健全的法制体系可吸引外资流入；而政局动荡、财政赤字高企、通胀严重等宏观管理不善会触发资本恐慌性逃离，导致严重经济动荡。持行为金融学派观点的Rodrick (2001)等认为，国际资本市场上的资本流动更多地由投资者情绪所主宰而与宏观经济基本面关系不大，因此不存在所谓的纪律效应。


• Empirical exploration about the relationship

between economic performance and capital controls:

kchinr vs. economic fundamentals

演示者

演示文稿备注

Rodrick从微观角度分析，资本管制有着显著的经济成本，将导致资源配置的低效和错配，降低生产效率和增长潜力，并且容易滋生扭曲和腐败。这些后果会滋长经济不稳定因素，成为危机的诱因之一。Rajan and Zingales (1998) 认为在相对封闭的资本市场环境中，政府、银行与关系企业之间的资金运作纽带才较易维持，而关系贷款必然导致坏账率上升和产生各种扭曲的激励，因此资本管制是滋生裙带资本主义的温床从宏观层面看来，Obstfeld (1998)，Tytell and Wei (2005)等都提出金融开放具有“纪律效应”（“discipline effect”）：政府的良治、健康的宏观经济环境、健全的法制体系可吸引外资流入；而政局动荡、财政赤字高企、通胀严重等宏观管理不善会触发资本恐慌性逃离，导致严重经济动荡。持行为金融学派观点的Rodrick (2001)等认为，国际资本市场上的资本流动更多地由投资者情绪所主宰而与宏观经济基本面关系不大，因此不存在所谓的纪律效应。

Economic fundamentals vs. Chinn-Ito Rating Index kchinr

Variables 1 2 3 4 5

M2/non gold reserves 8.149 4.003 3.556 3.275 3.167

Domestic credit growth 21.717 16.763 16.216 15.246 13.569 DC to private sector growth 24.459 17.425 18.478 18.589 15.777

DC to private sector(%M2) 14.311 10.616 12.604 12.100 10.872

M2 growth 24.244 17.234 17.687 16.402 14.068

Budget balance(%GDP) -0.841 -2.137 -1.675 -1.525 -0.896

Central govt debt(%GDP) 26.873 59.416 52.921 42.927 39.842

inflation 17.034 8.191 8.934 6.598 4.154

Investment (%GDP) 19.965 20.600 22.657 21.576 23.898

variables 1 2 3 4 5

Investment growth 4.999 5.622 6.057 6.966 7.838

Consumption growth 3.251 4.005 4.463 4.105 5.745

GDP growth 4.000 4.400 4.755 4.253 5.668

Export growth 4.800 5.955 6.695 6.700 8.303

openness 46.176 56.063 68.769 68.036 96.161

De facto k open1 68.200 94.600 96.400 105.400 194.500

De facto k open2 34.000 41.100 48.500 49.900 107.400

Debt/equity ratio 5.460 4.314 2.812 2.183 2.730


• Capital control practices are not effective in limiting capital inflows or outflows. – Edwards(1999，2001)，Simone and Sorsa (1999)，

Valdés and De Gregorio (2000)，Cowan and De Gregorio (2005) conclude that the “encaje” policy didn’t effectively reduce the total volume of capital inflows, but only had limited effect in lengthening the maturity of capital inflows.

– Garcia and Barcinski (1998)，Garcia and Valpassos (2000)，Goldfajn and Minella (2005)，Carvalho and Garcia (2006) come to similar conclusions regarding Brazil’s capital control practices.

Conclusions and Policy Implications

• In general, capital control does not reduce the probability of financial crises. On the contrary, the tighter the control, the more likely the inertia to postpone reforms, hence leading to destablizing elements, and resulting in a higher likelihood of financial crises.

• Under the ongoing trend of global financial integration, capital control measures are becoming increasingly ineffective while incurring increasingly higher costs and distortions.

• A wiser approach to strenghen financial safety is to push on necessary reforms and institutional development, to pursue sustainable macroeconomic policies and to improve the macroeconomic fundamentals.

are capital controls effective in preventing financial crisesa

Documents