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Capital controls and the global financial cycle

Author

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  • Lovchikova, Marina
  • Matschke, Johannes
Abstract
Capital flows into emerging markets are volatile and risky, which sparked interest in active capital flow management. We first revisit the use of capital controls and discover a new stylized fact: emerging markets, which actively revaluate their capital flow restrictions, increase capital inflow controls during episodes of major international financial distress when investors are very risk averse and markets volatile. We then explore this finding theoretically. We argue that heightened international financial volatility and investor risk aversion incentivize regulators to reduce the amount of risky emerging market debt to cope with elevated risk premiums. This rationale can be decentralized via capital inflow restrictions during periods of major financial distress, consistent with the empirical findings. The paper hence provides an alternative to the familiar macroprudential motivation for capital controls.

Suggested Citation

  • Lovchikova, Marina & Matschke, Johannes, 2024. "Capital controls and the global financial cycle," European Economic Review, Elsevier, vol. 163(C).
    • Handle: RePEc:eee:eecrev:v:163:y:2024:i:c:s0014292124000138
    DOI: 10.1016/j.euroecorev.2024.104684
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    More about this item

    Keywords

    Capital controls; Risk aversion; Volatility; Risk premium;
    All these keywords.

    JEL classification:

    • F36 - International Economics - - International Finance - - - Financial Aspects of Economic Integration
    • F38 - International Economics - - International Finance - - - International Financial Policy: Financial Transactions Tax; Capital Controls
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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