Friday, October 19, 2012

The IMF's Unhelpful Retreat on Capital Controls

 Something I've been meaning to get to, that was brought to my attention the other day via Scott Sumner. It seems the IMF has "rethought" its position on capital controls in the wake of the financial crisis and lackluster global recovery. So what's this about? Here's a link to an article that lauds the decision, but nevertheless provides some good background
My understanding is that the IMF is working off two justificaitons for capital controls: 
1. The financial crisis was contagious via the international mobility of financial assets. American mortgage securities were bought and sold by institutions and funds around the world, some of which are located in developing nations. The revaluation of these assets therefore caused disruption to economies beyond those that originated them. 
2. Many advanced economies remain depressed, with the result that both real and nominal interest rates remain low. With domestic returns to capital low, savings are increasingly flowing out of advanced economies and into develping economies where the marginal product of capital is higher. The IMF sees these new capital flows as potentially destabilizing, an argument they used to dismiss until the capital flows of the 2000's proved destabilizing. 
These justifications seem reasonable on their face. Why shouldn't policy makers in developing markets have tools available to protect their economies from the demonstrated volatility of financial asset prices in global capital markets? Here's the caveat: CAPITAL THEN WAS FLOWING IN THE OPPOSITE DIRECTION! Savings from China and Russia were being routed into American and European finanical assets. Now American savings are being routed into financial assets and FDI projects in developing markets, a shift that standard economic theory would predict. Effectively, the global imbalances in merchandise trade and financial assets are beginning to reverse themselves. And the IMF wants to reverse that reversal. 

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