How effective are China's capital controls?

Abstract

Competing interpretations of the interaction of domestic monetary policy and the foreign exchange rate in China often arise from different assumptions regarding the effectiveness of capital controls. At one end of the spectrum is the view that capital controls merely alter the form of capital flows without altering their magnitude. In this view, the heavily managed renminbi exchange rate implies that China imports its monetary policy and lacks control over local short-term interest rates. At the other end is the view that capital controls are still binding enough to allow the Chinese government to set short-term interest rates, despite the limited flexibility of the exchange rate. The contrasts between these views sharpen in the context of growing cross-border flows under the current and capital accounts in the past 10 years as well as the accelerated foreign reserve accumulation since 2005.