For countries facing a big inflow of capital — with the attendant risks of asset bubbles — the use of capital controls “is justified as part of the policy toolkit to manage inflows,” a recent IMF paper wrote. Even if investors figure out ways around the controls, the restrictions still can be useful, the IMF said because “the cost of circumvention acts as ‘sands in the wheels’” and slows down investment.

The change in advice won applause from IMF critics, especially on the left, who have long believed that the Fund was too wedded to free flow of capital even if unhindered flows could inflate asset bubbles.

Now, the IMF came close to changing its mind again. “Even if capital controls prove useful for individual countries in dealing with capital inflow surges,” the IMF wrote  its semi-annual Global Financial Stability Report, “they may lead to adverse multilateral effects… A widespread reliance on capital controls may delay necessary macroeconomic adjustments in individual countries and, in the current environment, prevent the global rebalancing of demand and thus hinder the recovery of global growth.”

So, should a country use restrictions on capital — which can be in the form of a tax or increased reserve requirements — or not?

The IMF isn’t clear. It seems to back them as a short-term measure, but not a long-term one, but doesn’t give specific advice how to tell one situation from another. Here’s the IMF’s best shot: “Since the use of capital controls is advisable only to deal with temporary inflows… they can be useful even if their effectiveness diminishes over time,” the GFS report suggests. “However the decision to implement capital controls should consider their distortionary effects” too.

Effie Psalida, an IMF economist, says the two papers on capital control “complement” each other.

Maybe. Or maybe they confuse each other. For policy makers in developing countries: Good luck making the call.

Source: Wall Street Journal