In the post-financial crisis world, capital controls have become viewed in many quarters as an acceptable policy tool. A number of studies have investigated how controls may affect macroeconomic and financial performance. But how controls are implemented is also a topic of interest, in part because the inopportune use of these measures may exacerbate the conditions they are intended to ameliorate.

Charles Collyns of the Institute of International Finance presents a classification of the use of controls to deal with capital inflows. The first template is the “Classical Chinese”: the capital account is largely closed except for FDI flows, the exchange rate is fixed and there is a repressed domestic financial system.  But China itself is moving away from this method, as are many low-income countries. The second model is the “Textbook” pre-2008 IMF model: flexible exchange rates with the long-run goal of capital account liberalization. This model showed itself vulnerable to financial shocks in 2008. The third scheme is the “Brazilian Defense”: a floating exchange rate and the use of macroprudential and tax tools to restarin capital flows. This approach has also been utilized by India and Turkey. The fourth classification is dubbed by Collyns the “New Orthodoxy,” and is defined by a commitment to both an open capital account and the development of domestic financial markets. Mexico is offered as an example country that uses such an approach.

If the “Classical Chinese” and the “Textbook” models are being discarded, then one popular alternative is the discretionary use of capital controls. But are capital controls used to avoid inflows that lead to credit bubbles and a boom-bust cycle? A new paper by Andrés Fernández, Alessandro Rebucci and Martín Uribe examines whether policymakers use capital controls in a macroprudential manner. If they were, we would expect to see a tightening of controls on inflows and a relaxation of restrictions on outflows during expansions, and the opposite pattern of policy measures during downturns.

The authors use three indicators—the output gap, the cyclical component of the real exchange rate, and the cyclical component of the current account—to date their boom-and-bust episodes. They update Schindler’s index of capital controls, which distinguishes among controls on inflows and outflows on six types of assets. The authors report that over the period of 2005-2011 there was no correspondence of changes in capital controls and macroeconomic conditions. Controls were not responsive to economic expansions or contractions, over- or undervaluations of the real exchange rate or large current account imbalances.

They offer two interpretations for their results. One is that theory has outrun practice, and controls will become increasingly used in a macroprudential fashion as policymakers become accustomed to using them in this fashion. The second interpretation is that there are other factors that determine the cyclical properties of the usage of capital controls. But what?

There was a literature on the political and economic determinants of capital account liberalization in the 1980s and 1990s, summarized by Eichengreen. Among the factors found to contribute to decontrol were the deregulation of domestic financial markets, the abandonment of exchange rate pegs, and a trend towards democratization in many developing countries. But Eichengreen cautioned that there might have been other factors that were difficult to measure but nonetheless significant. The latest contributions to the literature on the use of capital controls indicate that there are still unanswered questions regarding their implementation.