Capital Controls, Exchange Rate Volatility and External Vulnerability

Sebastian Edwards, Roberto Rigobon

NBER Working Paper No. 11434
Issued in June 2005
NBER Program(s):International Finance and Macroeconomics Program

We use high frequency data and a new econometric methodology to evaluate the effectiveness of controls on capital inflows. We focus on Chile's experience during the 1990s and investigate whether controls on capital inflows reduced Chile's vulnerability to external shocks. We recognize that changes in the controls will affect the way in which different macro variables relate to each other. We take this problem seriously, and we develop a methodology to deal explicitly with it. The main findings may be summarized as follows: (a) A tightening of capital controls on inflows depreciates the exchange rate. (b) We find that the "vulnerability" of the nominal exchange rate to external factors decreases with a tightening of the capital controls. And (c), we find that a tightening of capital controls increases the unconditional volatility of the exchange rate, but makes this volatility less sensitive to external shocks.

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Document Object Identifier (DOI): 10.3386/w11434

Published: Sebastian Edwards & Roberto Rigobon, 2009. "Capital controls on inflows, exchange rate volatility and external vulnerability," Journal of International Economics, vol 78(2), pages 256-267.

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