How central bank 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 in advanced market economies. It presents a novel dataset that 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 income earned by foreigners in the German bond market, transaction taxes on bonds and shares, as well as limits on the issuance and use of foreign DM debt securities; it also banned innovative products 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 divergent patterns of financial market development. Economies that swiftly removed restrictions enhanced the conditions for the development of domestic financial markets (e.g., the 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 Keynesian theory with my own approach which stresses power struggles within the state between central banks and government officials to demonstrate that different approaches to controls went back to central bankers' intrinsic policy preferences in the macroeconomic realm. Central bankers generally hold more conservative macroeconomic views--they 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 bankers' preferences regarding capital controls between the 1960s and 1980s: as capital mobility increased, monetary authorities endorsed restrictions if they expected them to advance price and currency stability. However, this was not the case across all Western economies.

Some economies (such as Germany) attracted massive capital inflows because of their prudent macroeconomic policies--inflation and sovereign debt levels were low and the current account was in surplus. Capital inflows generated inflation and made it more difficult for the Bundesbank to ensure fiscal restrictiveness as municipalities borrowed in international debt markets. 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 triggered further capital 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 more mobile markets punished the government for increases in government spending and thereby indirectly enforced austerity.

The article, therefore, shows that central banks in both finance- and export-led economies sought macroeconomic stability and attempted to achieve it through tools that would impose fiscal discipline on state officials. However, while in the German context of capital inflows this was most effectively achieved through the continued use of controls, 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 over macroeconomic policy, but it adds that in some domestic contexts implementing new controls was more effective in achieving that very same goal.