Regulating Capital Flows in Emerging Markets: the IMF and the Global Financial Crisis

In the wake of the financial crisis the of the 1990s, the International Monetary Fund (IMF) began to publicly express support for what had traditionally been referred to as ‘capital controls’. In addition to public statements, the IMF underwent a systematic reevaluation of Fund policy on the matter, and published an official view on the economics of capital flows. The IMF concluded that capital account liberalization is not always the most optimal policy and that there are situations where capital controls – rebranded as ‘capital flow management measures’ (CFMs) – are appropriate.

This shift surprised many as mainstream economic thought at the time generally saw capital account liberalization as an optimal policy and saw the regulation of capital flows as inherently distortionary from that optimum. Around the time of the global financial crisis, however, a number of economic theorists began to question the extent to which capital account liberalization is optimal, especially in the presence of information externalities.

While there is an emerging literature on the extent to which the IMF has changed its policy and discourse with respect to managing capital flows, there is yet systematic research that quantitively examines the extent to which the IMF has actually changed its policy advice.

A working paper by Kevin P. Gallagher and Yuan Tian empirically examines the extent to which the change in IMF discourse on these matters has resulted in significant changes in IMF policy advice. The authors create a database of IMF Article IV reports and examine whether the financial crisis had an independent impact on IMF support for capital controls.

The authors find that the financial crisis had a significant influence on the IMF’s decisions about level of support for capital control. This is especially true for emerging market economies in Asia. Overall, the crises has a significant impact on IMF diagnosis of whether capital flows are a source of vulnerability in emerging markets. The IMF was also more willing to discuss CFMs after the crises and more often supported the use of CFMs. This support did wane after the crises became less significant, but the overall increase suggests that the IMF has changed its actual behavior.

In December 2017, this working paper was published as a journal article in the Review of Development Finance.