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Capital controls and the real exchange rate: Do controls promote disequilibria?

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  • Montecino, Juan Antonio

Abstract

The consensus view is that capital controls can effectively lengthen the maturity composition of capital inflows and increase the independence of monetary policy but are not generally effective at reducing net inflows and influencing the real exchange rate. This paper studies the adjustment dynamics of the real exchange rate towards its long-run equilibrium and presents empirical evidence that capital controls increase the persistence of misalignments. Allowing the speed of adjustment to vary according to the intensity of restrictions on capital flows, it is shown that the real exchange rate converges to its long-run level at significantly slower rates in countries with capital controls. This result is stronger when the exchange rate is undervalued and is independent of confounding factors such as the exchange rate regime and other forms of heterogeneity affecting the speed of adjustment. I also find evidence that controls on capital inflows have greater effects than controls on outflows. In addition, while the combination of capital controls with a fixed or managed exchange rate regime significantly increases the persistence of misalignments, controls appear to loose traction under more flexible exchange rate arrangements.

Suggested Citation

  • Montecino, Juan Antonio, 2018. "Capital controls and the real exchange rate: Do controls promote disequilibria?," Journal of International Economics, Elsevier, vol. 114(C), pages 80-95.
    • Handle: RePEc:eee:inecon:v:114:y:2018:i:c:p:80-95
    DOI: 10.1016/j.jinteco.2018.05.005
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    Keywords

    Capital flows; Capital controls; Real exchange rate;
    All these keywords.

    JEL classification:

    • F2 - International Economics - - International Factor Movements and International Business
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F36 - International Economics - - International Finance - - - Financial Aspects of Economic Integration
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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