How central banks' differential preferences for capital controls shaped growth models

My article "Central banks, monetary stability, and the varieties of capital control liberalization" challenges the general view that restrictions on capital flows were evenly removed in the 1970s and 1980s throughout the world of advanced market economies. It presents a novel dataset which measures the intensity of capital control use across 21 advanced market economies which shows that while officials in finance-led economies had removed most controls by the mid-1980s, officials in export-led economies retained controls into the 1990s.

The German Bundesbank, for instance, administered a range of restrictions that limited international participation in domestic bond markets until the late 1990s (e.g., a 25 percent tax on foreigner income generated in the German bond market, transaction taxes on bonds and shares, as well as limits on issuance and use of foreign DM debt securities; they also banned innovative produces such as floating rate, FX-linked and zero-coupon bond issuances, certificates of deposit and interest-rate swaps). The Bank of England, however, supported the full liberalisation of the capital account which was achieved by the early 1980s.

I show that these differences in capital control liberalisation contributed to differential financial market development. Economies which swiftly removed restrictions enhanced the conditions for the development of domestic financial markets (e.g., City of London), while those which retained controls restricted the international integration of domestic markets and limited the emergence of domestic financial centres (e.g., Frankfurt).

The article links Neo-Keynesian theory with my own approach which stresses power struggles within the state--between central banks and government officials--to demonstrate that the different choices in controls went back to central banker's intrinsic policy preferences in the macroeconomic realm. Central bankers generally hold more conservative macroeconomic views--seek price stability and low sovereign debt--than governments which tend to support more expansive macroeconomic programmes and are less concerned with higher levels of inflation. These intrinsic interests shaped central bank control preferences between the 1960s and 1980s: as capital mobility increased, monetary authorities endorsed restrictions when they expected them to advanced price and currency stability. However, this expectation depended on the macroeconomic context within which officials operated.

As capital mobility increased in the 1960s, some economies (Germany) attracted massive capital inflows through prudent policy orientation--inflation and sovereign debt levels were low and the current account was in surplus. Capital inflows destabilised the monetary sphere--generated more inflation--and made it more difficult for the Bundesbank to ensure fiscal restrictiveness as municipalities indebted themselves in international debt markets as capital became available through the influx of funds. Ironically, capital controls became, in the eyes of Bundesbankers, a panacea to restore austerity in the German economy.

British officials, on the other hand, were confronted with capital outflows due to high sovereign debt and inflation levels, as well as current account deficits. Under these circumstances, stability could not be restored through the use of controls--outflow controls incited even higher levels of outflows as financial market actors feared that investments would become locked in. Thus, Bank of England officials endorsed the quick removal of all controls viewing this approach as a lever to enforce fiscal austerity--as capital became even more mobile markets punished the government for hikes in government spending and thereby indirectly enforced austerity.

The article, therefore, argues that central banks in both finance- and export-led economies sought macroeconomic stability and attempted to achieve it through tools which would enforce austerity onto state officials. However, while in the German context of capital inflows this was most effectively achieved through the extension of control use, in the UK context it was most effectively achieved through control liberalisation. The article contributes to the depoliticisation literature which argues that state officials strategically pursue financial liberalisation to disarm democratic influence on the macroeconomic sphere, but it adds that in some domestic contexts implementing new controls was more effective to achieve that very same goal.