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Alessandro Rebucci and Chang Ma

This paper reviews selected post–Global Financial Crisis theoretical and empirical contributions on capital controls and identifies three theoretical motives for the use of capital controls: pecuniary externalities in models of financial crises, aggregate demand externalities in New Keynesian models of the business cycle, and terms of trade manipulation in open-economy models with pricing power. Pecuniary and demand externalities offer the most compelling case for the adoption of capital controls, but macroprudential policy can also address the same distortions. So capital controls generally are not the only instrument that can do the job. If evaluated through the lenses of the new theories, the empirical evidence reviewed suggests that capital controls can have the intended effects, even though the extant literature is inconclusive as to whether the effects documented amount to a net gain or loss in welfare terms. Terms of trade manipulation also provides a clear-cut theoretical case for the use of capital controls, but this motive is less compelling because of the spillover and coordination issues inherent in the use of control on capital flows for this purpose. Perhaps not surprisingly, only a handful of countries have used capital controls in a countercyclical manner, while many adopted macroprudential policies. This suggests that capital control policy might entail additional costs other than increased financing costs, such as signaling the bad quality of future policies, leakages, and spillovers.