Capital Controls on Outflows: New Evidence and a Theoretical Framework

IMF Working Papers, July 26, 2024

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Study focus: capital controls on outflows (CCOs) in situations of macroeconomic and financial distress.
Main empirical finding: CCO implementation is associated with crises and declines in GDP growth.
Theoretical contribution: a framework consistent with the empirical findings that yields policy and welfare lessons.
Key mechanisms: costly coordination failures by foreign investors; CCOs can act as coordination devices.
Trade-off: CCO benefits from avoiding coordination failures can make them optimal even if CCOs entail deadweight losses; if deadweight losses are large, CCOs are detrimental for welfare.
Policy challenges: optimal CCOs can suffer from time inconsistency; political opportunism may limit CCO policy.
Implication: government credibility and reputation building are critical for successful implementation of CCOs.

Central theoretical ingredients:
- Costly coordination failures by foreign investors.
- Suitably tailored CCOs can sometimes avoid these coordination failures.
Welfare trade-offs:
- Benefits from CCOs as coordination devices versus deadweight losses caused by CCOs.
- If deadweight losses are large, CCOs reduce welfare.
Policy dynamics:
- Optimal CCO policies can be time-inconsistent.
- Political opportunism can constrain CCO policy implementation.

Design CCOs to serve as coordination devices to mitigate costly investor coordination failures.
Weigh directly the deadweight losses of CCOs against coordination benefits; avoid CCOs when deadweight losses are large.
Strengthen government credibility and build reputation to mitigate time inconsistency and limit political opportunism that undermines CCO effectiveness.