Financial Development and the Effects of Capital Controls

Research Article


This paper examines how the 1990s capital account liberalization policy trend affected international capital flows, and tests a new hypothesis that the depth and efficiency of the domestic financial system impacts the efficacy of capital account policy. The paper exploits a recently published IMF database on financial development that spans the period 1980–2014 and includes both developing and developed countries. The results confirm that policy on average does not have a statistically significant effect on accumulated gross capital flows, when controlling for other factors. I also find little effect on flows disaggregated by type and direction. However, interacting capital account policy and financial development, I do find that for financially developed countries, policy has the expected effect –policy openness leads to capital flows. Finally, I provide evidence that the impact of policy on a country’s share of global flows is also influenced by its level of financial development. These results are robust to using two alternative de jure policy measures. The implication is that the effectiveness of capital account liberalization requires developing the domestic financial system.


Financial globalization Financial integration Financial development Capital flows Capital control measures 

JEL Classification

F3 F4 



  1. Alesina A, Grilli V, Milesi-Ferretti GM (1993) The political economy of capital controls. CEPR discussion papers (793)Google Scholar
  2. Alfaro L, Chanda A, Kalemli-Ozcan S, Sayek S (2004) FDI And economic growth: the role of local financial markets. J Int Econ 64(1):89–112CrossRefGoogle Scholar
  3. Antras P, Caballero R (2009) Trade and capital flows: a financial frictions perspective. J Polit Econ 117(4):701–744CrossRefGoogle Scholar
  4. Arribas I, Perez F, Tortosa-Ausina E (2011) The determinants of international financial integration revisited: the role of networks and geographic neutrality. Studies in Nonlinear Dynamics and Econometrics 15(1):1558–3708Google Scholar
  5. Bartolini L, Drazen A (1997) Capital-account liberalization as a signal. Am Econ Rev 87(1):138–154Google Scholar
  6. Beck T, Demirg-Kunt A, Levine R (2000) A new database on financial development and structure. World Bank Econ Rev 14:597–605CrossRefGoogle Scholar
  7. Bianchi J (2011) Overborrowing and systemic externalities in the business cycle. Am Econ Rev 101(7):3400–3426CrossRefGoogle Scholar
  8. Binici M, Hutchison M, Schindler M (2010) Controlling capital? Legal restrictions and the asset composition of international financial flows. J Int Money Financ 29(4):666–684CrossRefGoogle Scholar
  9. Chang R, Velasco A (2001) A model of financial crises in emerging markets. Q J Econ 116(2):489–517CrossRefGoogle Scholar
  10. Chinn M, Ito H (2007) A new measure of financial openness. J Int Money Financ 26:546–569CrossRefGoogle Scholar
  11. Cihak M, Demirguc-Kunt A, Feyen E, Levine R (2012) Benchmarking financial systems around the world. World bank policy research working paper, August (6175)Google Scholar
  12. Clark W, Hallerberg M, Keil M, Willett T (2012) Measures of financial openness and interdependence. Journal of Financial Economic Policy 4(1):58–75CrossRefGoogle Scholar
  13. Deidda B, Fattouh L (2002) Non-linearity between finance and growth. Econ Lett 74:339–345CrossRefGoogle Scholar
  14. Eberhardt M, Teal F (2011) Econometrics for grumblers: a new look at the literature on cross-country growth empirics. J Econ Surv 02(25):109–155CrossRefGoogle Scholar
  15. Eichengreen B (2001) Capital account liberalization: What do the cross-country studies tell us?. The World Bank Econ Rev 15(3):341–365CrossRefGoogle Scholar
  16. Faria A, Mauro P (2005) Institutions and the external capital structure of countries. IMF working paper, (04/236)Google Scholar
  17. Fernandez A, Rebucci A, Uribe M (2013) Are capital controls prudential? An empirical investigation. NBER working paper series, (19671)Google Scholar
  18. Fernandez A, Klein MW, Rebucci A, Schindler M, Uribe M (2016) Capital control measures: a new dataset. IDB working paper series (IDB-WP-573)Google Scholar
  19. Forbes K, Warnock F (2012) Capital flow waves: surges, stops, flight and retrenchment. J Int Econ 88:235–251CrossRefGoogle Scholar
  20. Fratzscher M (2012) Capital flows, push versus pull factors and the global financial crisis. J Int Econ 88:341–356CrossRefGoogle Scholar
  21. Von Furstenberg GM (1998) From worldwide capital mobility to international financial integration: a review essay. Open Econ Rev 9:53–84CrossRefGoogle Scholar
  22. Haque N, Pesaran MH, Sharma S (1999) Neglected heterogeneity and dynamics in cross-country savings regressions. IMF working papers 99/128, international monetary fundGoogle Scholar
  23. Hernandez M (2015) Estimating capital flows to emerging market economies with heterogeneous panels. Banco de Mexico working papers 2015–03Google Scholar
  24. Karcher S, Steinberg D (2013) Assessing the causes of capital account liberalization: How measurement matters. Int Stud Q 57:128–137CrossRefGoogle Scholar
  25. Kaufmann D, Kray A (2017) Worldwide Governance indicators. The world bank groupGoogle Scholar
  26. King R, Levine R (1993) Finance and growth: Schumpeter might be right. Q J Econ 108(3):717–737CrossRefGoogle Scholar
  27. Kitano S, Takaku K (2017) Capital controls and financial frictions in a small open economy. Open Econ Rev 28:761–793CrossRefGoogle Scholar
  28. Klein MW (2012) Capital controls: Gates versus walls. Brook Pap Econ Act Fall:317–355CrossRefGoogle Scholar
  29. Korinek A (2014) Regulating capital flows to emerging markets: an externality view. University of Maryland working paperGoogle Scholar
  30. Kose MA, Prasad E, Taylor A (2009) Thresholds in the process of international financial integration. NBER Working Paper 14916Google Scholar
  31. Kose MA, Prasad E, Rogoff K, Wei S-J (2006) Financial globalization: a reappraisal. IMF working paper WP/06/189Google Scholar
  32. Lane P (2013) Financial globalisation and the crisis. Open Econ Rev 24:555–580CrossRefGoogle Scholar
  33. Lane P, Milesi-Ferretti GM (2003) International financial integration. IMF working paper WP/03/86Google Scholar
  34. Lane P, Milesi-Ferretti GM (2006) The external wealth of nations mark II: Revised and extended estimates of foreign assets and liabilities 1970-2004. IMF working paper WP/06/69Google Scholar
  35. Lane P, Milesi-Ferretti GM (2008) The drivers of financial globalization. IIIS Discussion paper no. 238,Google Scholar
  36. Levine R (1997) Financial development and economic growth: Views and agenda. J Econ Lit 35(2):688–726Google Scholar
  37. Levine R, Loayza N, Beck T (2000) Financial intermediation and growth: Causality and causes. J Monet Econ 46:31–77CrossRefGoogle Scholar
  38. Martin P, Rey H (2006) Globalization and emerging markets: With or without crash. Am Econ Rev 96(5):1631–1651CrossRefGoogle Scholar
  39. Mody A, Murshid AP (2005) Growing up with capital flows. J Int Econ 65 (1 (January)):249–66CrossRefGoogle Scholar
  40. Montiel P, Reinhart C (1999) Do capital controls and macroeconomic policies influence the volume and composition of capital flows? Evidence from the 1990s. J Int Money Financ 18(4):619–35CrossRefGoogle Scholar
  41. Okada K (2013) The interaction effects of financial openness and institutions on international capital flows. J Macroecon 35:131–143CrossRefGoogle Scholar
  42. Ostry J, Ghosh A, Habermeier K, Chamon M, Qureshi M, Reinhart D (2010) Capital inflows: the role of controls. IMF staff position note, (SPN/10/042)Google Scholar
  43. Pesaran M (2012) Testing weak cross-sectional dependence in large panels. CWPE, 1208Google Scholar
  44. Pesaran M, Smith R (1995) Estimating long-run relationships from dynamic heterogeneous panels. J Econ 68:79–113CrossRefGoogle Scholar
  45. Portes R, Rey H, Yonghyup O (2001) Information and capital flows: the determinants of transactions in financial assets. Eur Econ Rev 45(4–6):783–96CrossRefGoogle Scholar
  46. Prasad E, Rajan R, Subramanian A (2007) Foreign capital and economic growth. Brook Pap Econ Act 2:153–230CrossRefGoogle Scholar
  47. Quinn D, Toyoda M (2008) Does capital account liberalization lead to growth. Rev Financ Stud 21(3):1403–1449CrossRefGoogle Scholar
  48. Reed WR (2015) On the practice of lagging variables to avoid simultaneity. Oxf Bull Econ Stat 77:897–905CrossRefGoogle Scholar
  49. Schindler M (2009) Measuring financial integration: a new dataset. IMF Staff Pap 56(1):222–238CrossRefGoogle Scholar
  50. Svirydzenka K (2016) Introducing a new broad-based index of financial development. IMF working paper, January(16/5)Google Scholar

Copyright information

© Springer Science+Business Media, LLC, part of Springer Nature 2019

Authors and Affiliations

  1. 1.Banco de MéxicoCiudad de MéxicoMexico

Personalised recommendations