Policy Rules for Capital Controls

BIS Working Papers No 670
November 2017



The paper examines two possible objectives - macroprudential or trade competitiveness - with which policymakers in emerging market economies (EMEs) may have used capital controls.


There is surprisingly little factual evidence concerning the objective with which capital controls have been used in EMEs. The paper attempts to answer this question by using an approach based on a policy reaction function.
The paper also proposes a new measure of an EME's real currency appreciation against its main trade competitors as a way of disentangling macroprudential and competitiveness motivations.


The paper uses a weekly data set on capital controls that directly quantifies the actions taken by 21 major EMEs over the period 2001-15. It finds that the assumed policy reaction function traces successfully the systematic pattern behind the tools' use. Moreover, the adoption of tightening measures on net capital inflows seems to be consistent with both macroprudential and competitiveness motivations.
While the results suggest that capital controls did target systemic risk, they also indicate that the measures did not necessarily target systemic risk arising from excessive foreign borrowing. Rather, it appears that controls on foreign credit were tightened when domestic bank credit to the private non-financial sector was booming, and vice versa. That said, the development of governance arrangements for macroprudential policy has led to a more predictable response of capital controls to systemic risk concerns.



This paper attempts to borrow the tradition of estimating policy reaction functions in monetary policy literature and apply it to capital controls policy literature. Using a novel weekly dataset on capital controls policy actions in 21 emerging economies over the period 1 January 2001 to 31 December 2015, I examine the competitiveness and macroprudential motivations for capital control policies. I introduce a new proxy for competitiveness motivations: the weighted appreciation of an emerging-market currency against its top five trade competitors. The analysis shows that past emerging-market policy systematically responds to both competitiveness and macroprudential motivations. The choice of instruments is also systematic: policy-makers respond to competitiveness concerns by using both instruments - inflow tightening and outflow easing. They use only inflow tightening in response to macroprudential concerns. I also find evidence that that policy is acyclical to foreign debt but is countercyclical to domestic bank credit to the private non-financial sector. The adoption of explicit financial stability mandates by central banks or the creation of inter-agency financial stability councils increased the weight of macroprudential factors in the use of capital controls policies. Countries with higher exchange rate pass-through to export prices are more responsive to competitiveness concerns.

JEL classification: F3, F4, F5, G0, G1

Keywords: capital controls, macroprudential policy, competitiveness motivations, capital flows, emerging markets, policy rules