Policy Rules for Capital Controls

This paper attempts to borrow the tradition of estimating policy reaction functions in monetary policy literature and apply it to capital controls policy literature. Using a novel weekly dataset on capital controls policy actions in 21 emerging economies over the period 1 January 2001 to 31 December 2015, I examine the mercantilist and macroprudential motivations for capital control policies. I introduce a new proxy for mercantilist motivations: the weighted appreciation of an emerging-market currency against its top five trade competitors. There is clear evidence that past emerging-market policy systematically responds to both mercantilist and macroprudential motivations. The choice of instruments is also systematic: policy-makers respond to mercantilist concerns by using both instruments — inflow tightening and outflow easing. They use only inflow tightening in response to macroprudential concerns. I also find that policy is acyclical to foreign debt but is countercyclical to domestic bank credit to the private non-financial sector. The adoption of explicit financial stability mandates by central banks or the creation of inter-agency financial stability councils increased the weight of macroprudential factors in the use of capital controls policies. Countries with higher exchange rate pass-through to export prices are more responsive to mercantilist concerns.