Are capital controls a useful instrument of economic policy?

Essay, 2010

10 Pages, Grade: 1,3


1. Introduction

“Loose funds may sweep round the world
disorganizing all steady business.
Nothing is more certain than that the
movement of capital funds must be

Keynes, J.M.[1]

Already at the beginning of the post-war period Keynes warned against a free movement of capital flows and advocated for a regulation to protect the real economy from their destabilizing forces. Those warnings were taken seriously by the international community and the International Monetary Fund (IMF) allowed in its articles the use of capital controls. The attitude towards those controls changed remarkably during the 1980's when a general trend towards deregulation occurred.[2] This trend peaked in an attempt to include the purpose of liberalizing capital movements in the Articles of Agreements of the IMF.[3] Coinciding with the Asian Crisis, parts of the academic profession heavily opposed this idea and eventually, some of the fund's representatives revised their general opposition against capital controls.[4] Nonetheless, in big parts of the academic profession, capital controls carry a negative smack and the ultimate goal of free capital flows is promoted.[5] With the international financial crisis, however, capital controls came into vogue again. Recently, Brazil introduced a tax on foreign portfolio investment. Also at the G20 level, ways on how to regulate international capital flows are discussed.[6]

Whether this should be seen as a desirable development or not, boils down to the question if capital controls are a useful instrument of economic policy? In general capital controls are any kind of policy that limits or redirects capital account transactions.[7] So, the above mentioned question can be answered by looking at the situation of a fully liberalized capital account with its associated cost and benefits and see if state intervention in form of capital controls would be able to improve the situation. This discussion shall first rest on theoretical considerations and outline possible benefits of free capital flows. Thereafter, an important assumption, namely the Efficient Market Theorem (EMT), which allows for the prediction of those benefits, will be discussed. Subsequently, by dropping the EMT and introducing Keynesian uncertainty an alternative scenario is drawn and the effect of capital controls within this framework is examined. After this, some of the empirical research regarding the benefits of free capital flows will be examined and some of the areas where capital controls can play a beneficial role are introduced to the reader. Finally, the insights gained in the course of this paper will be summarized and an answer to the stated question will be given.

2. Are capital controls a useful instrument of economic policy?

In economic theory capital controls have received only scant attention. Mostly, it is assumed that controls of capital work similar as tariffs on goods - they are harmful for economic efficiency because they lead to a misallocation of resources. Therefore, freeing a country from those controls should be beneficial in various ways. Those benefits, similar to those to expect from free trade, rest on the differences between countries, such as different saving rates, age structures, investment opportunities or risk profiles.[8]

From an individual country's perspective, free capital flows should enable citizens to decrease their consumption volatility relative to output volatility. The idea here is that output cycles are generally not perfectly correlated over different regions and countries; financial asset trading can therefore decouple output and consumption. A more stable consumption is seen as welfare enhancing.[9] Similarly, it enables societies that age faster than others to trade consumption today against future consumption. One country's residents could therefore save for retirement, while residents of another country have more resource available today.[10]


[1] As quoted by Davidson (2006), p. 73

[2] Cf. Singh (2000), pp. 125f

[3] Cf. Kenen (1998), p. V

[4] Cf. Rogoff (2002)

[5] Cf. Singh, 2000, p. 135f

[6] Cf. Beattie, Wheatley (2009)

[7] Cf. Neely (1999), p. 15

[8] Cf. Neely (1999), p. 14

[9] Cf. Fischer (1998), p. 3

[10] Cf. Neely (1999), p. 14

Excerpt out of 10 pages


Are capital controls a useful instrument of economic policy?
Berlin School of Economics and Law
International Trade and Monetary Economics
Catalog Number
ISBN (eBook)
ISBN (Book)
File size
463 KB
Kapitalverkehrskontrollen, Capital, controls, IMF
Quote paper
Daniel Detzer (Author), 2010, Are capital controls a useful instrument of economic policy?, Munich, GRIN Verlag,


  • No comments yet.
Read the ebook
Title: Are capital controls a useful instrument of economic policy?

Upload papers

Your term paper / thesis:

- Publication as eBook and book
- High royalties for the sales
- Completely free - with ISBN
- It only takes five minutes
- Every paper finds readers

Publish now - it's free