Capital Controls: Myth and Reality, A Portfolio Balance Approach to Capital Controls

Abstract

The literature on capital controls has (at least) four very serious apples-to-oranges problems: (i) There is no unifled theoretical framework to analyze the macroeconomic consequences of controls; (ii) there is signiflcant heterogeneity across countries and time in the control measures implemented; (iii) there are multiple deflnitions of what constitutes a \success and (iv) the empirical studies lack a common methodology-furthermore these are signiflcantly \overweighted by a couple of country cases (Chile and Malaysia). In this paper, we attempt to address some of these shortcomings by: being very explicit about what measures are construed as capital controls. Also, given that success is measured so difierently across studies, we sought to \standardize the results of over 30 empirical studies we summarize in this paper. The standardization was done by constructing two indices of capital controls: Capital Controls Efiectiveness Index (CCE Index), and Weighted Capital Control Efiectiveness Index (WCCE Index). The difierence between them lies in that the WCCE controls for the difierentiated degree of methodological rigor applied to draw conclusions in each of the considered papers. Inasmuch as possible, we bring to bear the experiences of less well known episodes than those of Chile and Malaysia. Then, using a portfolio balance approach we model the efiects of imposing short-term capital controls. We flnd that there should exist country-speciflc characteristics for capital controls to be efiective. From these simple perspective, this rationalizes why some capital controls were efiective and some were not. We also show that the equivalence in efiects of price- vs. quantitycapital control are conditional on the level of short{term capital ∞ows.