The Temptation of Capital Controls

As often happens during financial crises, governments become tempted to put in place capital controls. Is your currency losing value? No problem, just restrict capital outflows! In reality, of course, there are longer-term costs to such policies that have to be balanced against any potential short-term gain.

This crisis is no different, and some speculation has cropped up about countries potentially imposing such controls. However, major emerging markets have denied the rumors; for example, Russian Premier Vladimir Putin recently said "[t]here is no question of any state bans." Similarly, the Governor of Indonesia's Central Bank has issued "a renewed pledge that Jakarta [is] committed to free capital movement."

While most emerging markets have steered clear of imposing new capital controls, the temptation will undoubtedly remain for some time. Debate on the topic is lively - here are a few notable voices:

• A recent paper from the World Bank on The Unfolding Crisis argues that
  "[t]here is a continuum of policy measures to enhance confidence and stem the risk of bank runs and capital outflows, of which the introduction of capital controls should be considered as instruments of last resort."
• Guillermo Calvo gives tentative support to controls on capital outflows, although he remains skeptical of controls on capital inflows (Hat tip: Dani Rodrik).
• Bob Geldof comes out in support of the Tobin tax just before the recent G20 summit.
• A Harvard Business School case study discusses the pros and cons of Malaysia's imposition of capital controls during the Asian financial crisis.
• A new World Bank working paper on Crises, Capital Controls, and Financial Integration finds that capital controls are effective in segmenting markets, although it takes no stance on whether or not this is beneficial.
• A new working paper from the Commission on Growth and Development on International Finance and Growth in Developing Countries takes an ambivalent view of financial openness but points out that "domestic financial deepening...makes capital controls ever costlier to enforce."