Policy Rules for Capital Controls

Abstract

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.