Buffering monetary and exchange rate shocks: are capital controls effective?

We demonstrate that capital controls can considerably mitigate the effects of monetary and exchange rate shocks and reduce the volatility of capital inflows to emerging countries. This study analyzed quarterly data of 32 emerging economies over the period between 2000 and 2019, and proposes two methods to identify capital control actions. Using panel analysis, Autoregressive Distributed Lag (ARDL), and local projections approaches, this study found that tighter capital controls may diminish monetary and exchange rate shocks and reduce capital inflows volatility. Furthermore, capital controls respond anti-cyclically to monetary shocks. Under capital controls, countries with floating exchange rate regimes have more potential to buffer monetary shocks. We also found that capital controls on inflows are more effective for lowering the volatility of capital inflows compared to capital controls on outflows.