Effectiveness of capital controls in Chile (academic paper, 2005)

Capital Controls, Exchange Rate Volatility and External Vulnerability

Sebastian Edwards, Roberto Rigobon
NBER Working Paper No. 11434, Issued in June 2005

This recent paper found that capital controls in Chile during the 1990s were effective in reducing the "country’s vulnerability to external disturbances":

The fact that Chile grew very fast during the 1990s – at an average of 7% percent per year – and that it was not significantly affected by the successive currency crises in the emerging markets, has bolstered the view that emerging economies should restrict short term capital flows. Indeed, Chile’s controls on capital inflows have been praised from very different quarters. Joseph Stiglitz, a persistent critic of globalization, has been quoted by the New York Times (Sunday February 1, 1998) as saying: “You want to look for policies that discourage hot money but facilitate the flow of long-term loans, and there is evidence that the Chilean approach or some version of it, does this.” And former U.S. Secretary of the Treasury Robert Rubin, an ardent supporter of free capital mobility has said:

“Control on the inflow, as opposed to the outflow, of short term investments might sometimes make sense as a transitional device. Chile had some apparent success in reducing reliance on volatile funds through restrictions on the inflow of short-term capital…”(Rubin 2003, p. 257).

We find that a tightening of the capital controls is associated with:

• a depreciation of the nominal exchange rate;
• an increase in the unconditional variance of the nominal exchange rate;
• and with a reduction in the vulnerability of the nominal exchange rate to external shocks, both to the mean and to the variance.

Our results indicate that capital controls on inflows have been – at least in Chile – more effective than what previous studies had suggested, in the sense of helping reduce the impact of external shocks on the nominal
exchange rate. That is, our results indicate that Chile’s controls on inflows helped reduce the country’s vulnerability to external disturbances.