Paul Lachine

Common Sense on Capital Controls

Those who claim that capital controls are ineffective seldom specify at what they are presumed to be ineffective. In fact, by reducing the share of short-term foreign-currency debt in a country’s total liabilities, capital controls can reduce vulnerability to financial crises.

SANTIAGO – Few policy debates are stranger than the one concerning capital controls. Mention the issue to a banker or a mainstream economist and you are likely to get a vehement reply: capital controls do not work, because speculators can evade them at little or no cost, but countries should never adopt such controls, because doing so is very costly. Am I the only one who finds this logic a bit crooked?

The next stage of the conversation is usually just as strange. When dealing with surges of potentially destabilizing capital inflows, capital controls are a no-no, but something called prudential regulation is quite okay. Capital controls, you are likely to be told, discriminate between transactions depending on the country of residence of the parties involved, and that is bad. Prudential regulation discriminates on the basis of the transaction’s currency of denomination or maturity, and that is good.

If this conversation is taking place at a cocktail party, at this point you would be well advised to ask for another drink.

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