How effective are capital controls? Evidence from Malaysia

Abstract

This paper examines the role of capital controls as a macroeconomic policy tool in light of the Malaysian experience. It consists of an econometric analysis of quarterly data over the period 1990-2010 using newly constructed capital inflow and outflow policy indexes as well as analytical narratives of episodes of controls imposed on inflows (1994) and outflows (1998-1999). The findings suggest that well-targeted controls have the potential to tame both short-term capital inflows and outflows without exerting a backwash effect on foreign direct investment, at least in the short to medium term. Controls on capital inflows introduced in the first half of 1994 helped moderate accumulation of short-term capital flows, particularly short-term bank credit. During 1998-1999, carefully designed temporary capital controls were successful in providing Malaysian policymakers a viable setting for applying the standard Keynesian therapy.