A critical analysis of capital controls: implications for crisis prevention and economic performance

This paper researches the effects of capital controls on the financial system’s stability, finding that such regulatory measures mitigate the risk of banking crises (a favourable outcome) while constraining economic growth (an adverse outcome). We deployed a dynamic panel logit model incorporating fixed effects to scrutinise data from diverse emerging and advanced economies from 2000 to 2022. Further, an impulse response function analysis was employed to gauge the aggregate impact of capital controls. We find that although capital controls can underpin economic stability, they can also trigger instability by inhibiting economic development. Notably, the benefits of diminishing the likelihood of a financial crisis tends to outweigh the negative ramifications for economic growth. Moreover, while the effects of capital controls manifest differently between emerging markets and developed economies, the influence of these controls persists across the spectrum of their intensity in both contexts. This is particularly salient for policymakers navigating the delicate interplay between capital movement regulations and the overarching objectives of economic expansion and financial stability.