As the ruble continued to tumble in December 2014, Russia’s economy minister denied that capital controls were being considered. But the failure of a series of interest rate hikes and $80 billion in central bank interventions to stop the ruble’s rout led many to conclude that some limits were likely, increasing the pressure to sell. Russia had already urged exporters to convert more foreign revenue into the local currency, a step some authorities say is tantamount to capital controls. The only countries to impose controls in 2014 were Ukraine, which acted as its conflict with Russia grew, and Ghana. Both eased the restrictions within months, in Ukraine after securing a $17 billion loan from the International Monetary Fund. Other countries rolling back limits imposed earlier included Argentina and Venezuela, where a currency crunch caused shortages of food and medicine and fueled the world’s highest inflation, and Cyprus, which had become the first country in the euro area to impose capital controls during a banking crisis in 2013. Iceland said in December it was ready to unwind controls six years after they were imposed as part of the government’s response to the banking collapse in 2008. China is starting to relax controls that have anchored the economy for three decades.
To discourage foreign money from flooding a national economy or leaving it high and dry, a government can restrict withdrawals from banks, limit foreign-exchange transactions or tax the purchase of stocks and bonds. These measures were uncommon until the 1930s, when countries started using them to keep scarce resources from flowing away during the Great Depression. After World War II, rules restricting capital flows became an established part of a world financial system. Only in 1971, when U.S. President Richard Nixon abandoned the dollar’s peg to gold, did major currencies start floating and countries lift controls. A new consensus favoring open capital markets lasted until the Asian financial crises of the late 1990s provided provisional evidence that capital controls could work: Malaysia recovered swiftly after imposing restrictions in September 1998. (South Korea recovered too, without them.) By 2010, the IMF was ready to acknowledge that capital controls can forestall financial crises.
Many economists now say there’s a time and place for limited capital controls. Still hotly debated is how well they work. Few doubt that capital flows across borders usually provide financing for high-return investment and bring technology, innovation and growth. Nor that the dismal economic performance of countries such as Venezuela and Argentina over the past few years shows that enduring capital controls distort allocation of resources and discourage investment. Limited controls on capital inflows are thought to prevent currency overvaluation and financial bubbles. In a financial crisis, restrictions on outflows give policy makers some breathing space to address the shortcomings in their economies and ward off panic selling. Controls are neither foolproof nor cost free. Investors find ways around them through financial innovation and bribery and they can prevent productive foreign investment. Then there’s the impossible trilemma — one cannot simultaneously have free capital flow and control of interest and exchange rates. Something has to give.
The Reference Shelf
- Federal Reserve Bank of St. Louis reviewed the history of capital controls in 1999.
- Economist Paul Krugman went against the conventional wisdom by endorsing Malaysia’s capital controls during the Asian Financial crisis.
- The IMF revealed its historical shift in its view toward capital controls in 2010.
- Economists including Kristin Forbes study the spillover effects of capital controls.
(This QuickTake includes a corrected reference to the “impossible trilemma.”)