Capital controls are state-imposed restrictions on moving money in or out of a country. If you have money inside a state with capital controls, then it is legally-difficult to lend that money to foreigners or use that money to buy foreign assets. In fact, to be binding, it even has to be difficult to use that money to freely import stuff. Otherwise you could move money out simply by buying something overseas on credit, importing it, and selling it to yourself at an inflated price.
Why might a government want to impose them?
- Governments sometimes impose capital controls during economic crises. They might do this to stem a panic. Say that people have started dumping assets and taking the money out of the country. (If they are not doing that, then they are likely using the money to buy other assets, which is less of a problem.) The fire sale is driving down asset prices and pushing otherwise healthy companies towards insolvency. In that situation, capital controls basically stop the foreigners from being able to dump their assets. It’s a way of forcing everyone to calm down, the way a bank facing a run might stop withdrawals for a little while.
- Capital controls can also be used to give central banks the ability to fight a crisis without worrying about the exchange rate. They can prints lots of money and do other unorthodox things without the fear that people will start dumping the currency. In countries where lots of companies have foreign-denominated debt, that is a good thing.
- Finally, governments can shift the pain of external adjustment by using controls. A collapse in the exchange rate has all sorts of distributional effects. If a government doesn’t like those effects, then it can use capital controls to shift them around. (Venezuela is doing this ... for so long that it long became massively counterproductive. But that is a different issue.)
Kris James Mitchener and Kirsten Wandschneider have a good working paper on capital controls during the Great Depression. What did they find?
- Controls worked on the most basic level, as in governments succeeded in making it hard to take money out of the country;
- Controls abetted recovery from the Depression ... but no more so than in the countries that just let their currencies depreciate;
- One of the reasons for (3) is that central banks seemed very reluctant to take advantage of the manuevering space that the controls provided. In short, they stuck with basically the same policies as the countries that let their currencies float, even though they no longer needed to.
What are the implications for the current Russian predicament? I see two. If the crisis really is a panic-driven flight, then the controls may work well. The Russian government has been informally imposing such controls for several weeks, mostly by ordering state-owned businesses to refrain from taking money out of the country.
On the other hand, if the crisis is more systemic, then the Russian government could use controls to keep the ruble from plunging further while it uses its foreign reserves to bail out various companies. That might be useful! It would keep import prices from spiking and keep various exporters solvent. But it is not clear that it would really produce less overall pain than just letting the ruble fall.
The problem does not seem to be driven by a short-term panic, so it seems that the Russia government has a difficult choice. But the lesson seems to be that capital controls do not do much good unless you have a plan for using the breathing room. Does anyone in Moscow?