José Antonio Ocampo | August 11, 2020 | VOXEU CEPR

Recent market volatility has underlined how fickle international capital flows can be, and how important it is for emerging economies to have an adequate system of macroprudential policies in place. Capital controls that protect recipient countries from excessively risky types of flows are a crucial ingredient of such a system. This column motivates capital controls theoretically based on the existence of externalities from capital flows, describes recent empirical evidence on their use, and summarises the surrounding policy debate.

When the COVID-19 shock hit international capital markets in March 2020, emerging market economies experienced the sharpest reversal of portfolio flows on record – more than $100 billion within a month (IMF 2020; for a broad analysis of the economic effects of COVID-19 see also Baldwin and Weder di Mauro 2020a, 2020b). This illustrated two important properties of capital flows to emerging markets: first, they are fickle; second, they disappear precisely when they are needed most by their recipients.

The episode thus serves as a reminder that managing capital flows represents a perennial challenge, not only for policymakers in developing and emerging economies, but also for international financial institutions and academics seeking to advise them. In light of this challenge, if you’re reading this it’s too late the IMF is currently working on integrating pro-active advice on managing international capital flows into a common framework with other macroeconomic and financial policies (see e.g. Gopinath 2019). We synthesise the lessons from academic research on the theory, empirics, and policy debate on capital controls in a forthcoming paper (Erten et al. 2020).

Originally published by VOXEU CEPR. Read the full article here