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Capital Controls and 21st Century Financial Crises:
Evidence from Colombia and Thailand

by Bruno Coelho and Kevin P. Gallagher
PERI Working Paper No. 213

January 2010

In the run-up to the financial crisis of 2007-2009 many developing nations fell victim to massive inflows of capital, capital that their financial systems found difficult to absorb. One policy option to respond to such inflows is unremunerated reserve requirements (URRs), one instrument among many that are referred to as “capital controls.” Two countries, Colombia and Thailand, deployed URRs in the second half of the decade. This paper analyses the extent to which those URRs were successful in reducing the overall level and composition of capital inflows, reducing exchange rate appreciation and volatility, stemming asset bubbles, and creating more independence for monetary policy.

GDAE researchers Bruno Coelho and Kevin P. Gallagher find that URRs were modestly successful in Colombia and Thailand, though Thailand was less of a success than Colombia. In Colombia the controls were able to reduce the overall volume of inflows and stem asset bubbles. In Thailand, the URR did reduce the overall volume of flows, and the announcement of the URR caused a sharp drop in asset prices. However, in both cases the controls were linked to exchange rate volatility and in Thailand asset prices recovered their upward trend the day after the announcement.

The results in this paper demonstrate that there is still an important role for capital controls in the 21st century, but given the complexity of global financial systems such controls need to be more sophisticated than in years past. The findings are particularly important in light of the pending US-Colombia Free Trade Agreement, since the investment provisions of that agreement would prohibit the Colombian government from using such capital controls to limit the domestic impacts of global financial crises.

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The Global Development and Environment Institute’s Globalization and Sustainable Development Program examines the economic, social and environmental impacts of economic integration in developing countries, with a particular emphasis on the WTO and NAFTA's lessons for trade and development policy. The goal of the program is to identify policies and international agreements that foster sustainable development.

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