Interaction Effect of Capital Controls and Macroeconomic Policies

Abstract

This study highlights recent approaches to reducing capital flow volatility using capital controls. Through a SVAR model, variance decomposition and shocks analysis, applied to 22 developed and developing countries over the period between 2000 and 2017, this study examines the effectiveness of capital controls in reducing capital flow volatility. The results show that the portfolio balance approach of capital controls can be applied and enables to predict capital inflow movements. The findings show asymmetric impacts of capital controls, where a floating exchange rate allows capital controls to be more effective compared to a fixed exchange rate. Furthermore, controls on capital inflows are more useful than controls on outflows. This study found that the exchange rate policy is more responsive to capital controls actions compared to the monetary policy.