If you’re Cypriot and you need to pay April rent tomorrow, you’ll need to get creative. Your landlord might not be happy with the usual cheque since she won’t be allowed to cash it for a month. The government has also banned ATM withdrawals above 300 euros ($384) per day. A debit or credit card transfers would do — those are still legal, unless you’re trying to send funds across the border, in which case there’s a 5,000 euro ($6,522) cap.
Such are the curbs on money movements the Cypriot government imposed to avoid a capital flight after announcing it would seize large chunks of bank deposits above 100,000 euro ($130,000) as part of a $13 billion bailout deal.
The move, which was sanctioned by the Eurozone authorities and the International Monetary Fund, startled a number of commentators. Capital controls? In Europe? Wasn’t that the stuff of autocrats who blame financial crises on Jewish speculators? Didn’t the IMF spend the 1990s excommunicating anyone who’d argue for limits on the free flow of capital from the Church of Sensible Economics Advisors Everyone Should Listen To?
Yes. But the consensus on capital controls has gradually evolved since then. The IMF’s blessing of Cyprus’ curbs isn’t exactly unprecedented. The Fund has quietly supported (opens a PDF) a number of economic programs that included efforts to stem capital flights, including in Argentina in 2002 and, more recently, Iceland in 2008. A cursory look at IMF publications on capital controls over the past ten years shows that its economists have long stopped being the preachers of unfettered financial liberalization they once were.
The catalyst for such a change of heart was arguably the Asian financial crisis of 1997-1998, where massive investment inflows (opens a PDF) enabled by rapid financial liberalization in a number of East Asian countries led to crippling capital flights and region-wide financial contagion once equity and housing bubbles popped. Alone among its neighbours, Malaysia embraced what was at the time nothing short of economic heresy and imposed a temporary and selective ban on transferring money out of the country. Despite the fact that Malaysia happened to be led by one of those Jewish-bashing populists at the time — as Paul Krugman, who changed his minds about capital controls around the same time, recalls — the move seems to have worked, allowing for a faster recovery and smaller drops in unemployment and real wages. Clearly, capital controls, if done properly, could help.
And that’s not the only page Western governments have been borrowing from Asia’s book. The idea of rules aimed at sheltering the whole financial system — as opposed to single institutions — from vulnerabilities and excessive risk also comes from there. Hong Kong, China, India and Singapore have been putting limits on things like how much leverage banks can take on and loan-to-value caps on mortgages long before these so-called “macro-prudential policies” became the buzzword among economist and regulators in North America and Europe after our very own financial meltdown five years ago. (Hat-tip to the Financial Times for posting and discussing this paper on the topic from Standard Chartered.)
Despite weathering the financial crisis rather well and boasting better financial regulations than most, Canada has picked up that lesson too. Just think of the Harper government’s four rounds of mortgage-rule tightenings since 2008: that’s macro-prudential policy aimed squeezing excessive risk out of the housing market. Or just count how many times the world “macro-prudential” appears in any given speech by Bank of Canada Governor Mark Carney.
Now, none of the above means that capital controls are unquestionably good or that macro-prudential policies always work. Heavy handed or permanent curbs on money movements will always have dreadful effects, distorting capital flows, stifling financial innovation and potential starving productive parts of the economy of much-needed investment. And tight housing market regulations haven’t avoided a massive real estate bubble in China.
Still, when it comes to economics, learning has clearly become a two-way street.