Development Studies Association
2012 Annual Conference
London, November 2012
Capital controls in Iceland.
Does anybody know what is
going to happen?
Pablo Aguirre
pablo.aguirre@icei.ucm.es
Instituto Complutense de Estudios Internacionales
Structure
•
•
•
•
•
•
•
Why is this case interesting?
Context and capital controls description
Determinants
Effects
Costs
Challenging liberalization
Final remarks
Capital controls in Iceland: why is it interesting?
• Economic theory: opened question
• Empirical analysis: opened question
• Capital controls: policy tool currently used,
debate ongoing
• Iceland: good study case
Context
• Imposed on 10-October-2008
• IMF Stand-By Agreement
– Legitimates capital controls: “needed tool”
– Main goal: avoid further ISK depreciation
• Outflows
– Residents: not allowed to purchase foreign currency to perform
any financial operation
– Non residents: not allowed to take investments out
• Inflows: free but…
• Current account transactions: no restrictions
Context
• Liberalization strategy ongoing
– Main goal: safeguard financial stability (= avoid capital flight)
– Problem: non-resident investors with short term assets worth 25% GDP
– Proceeding slowly so far
• Financial sector rescued (partially) and reestructured
– Cost = 43% GDP
– Main bank: 81% public.
• Progressive fiscal reform
• Main pillars of welfare state maintained
• Forecast: incipient economic recovering
Determinants: why capital controls?
• Different starting points from literature  do they fit to Iceland?
• Government’s “fears” (depreciation) (Magud and Reinhardt, 2006)  YES
• Curative or preventive controls (Edwards,1999)  CURATIVE
• To gain monetary policy independence (Krugman,1998; Grabel,2003)  YES
• To “buy time”: dealy unavoidable and needed changes on economy, thus
maintaining inefficiencies (Edwards,1999;Battilossi,2005)  NO
Effects: what we see
1. Uncertainty: would recovery vanish without capital
controls?
2. Exchange rate stabilization
3. Off-shore ISK market
4. Lower interest rates
5. Cheaper public debt (capital controls+other factors)
6. Overall effect: sustaining economic recovery
Exchange rate (ISK/EUR)
360
340
320
300
280
260
240
220
200
180
160
140
120
100
80
Jan-08 Apr-08 Jul-08
Oct-08 Jan-09 Apr-09 Jul-09
Oct-09 Jan-10 Apr-10 Jul-10
Offshore
Source: Central Bank of Iceland. Economic Indicators
Onshore
Oct-10 Jan-11 Apr-11 Jul-11
Oct-11
Central Bank interest rates
25.00
Overnight loan
discount rates
20.00
15.00
10.00
Loan against collateral
(nominal rate)
5.00
Current account
Ja
n07
M
ay
-0
7
Se
p07
Ja
n08
M
ay
-0
8
Se
p08
Ja
n09
M
ay
-0
9
Se
p09
Ja
n10
M
ay
-1
0
Se
p10
Ja
n11
M
ay
-1
1
Se
p11
Ja
n12
M
ay
-1
2
0.00
Source: Central Bank of Iceland. Interest Rates
General government gross debt
120.0
100.0
80.0
60.0
40.0
20.0
0.0
00
01
02
03
04
Source: Central Bank of Iceland. Economic Indicators
05
06
07
08
09
10
11
Treasury debt. Yields on primary market
18.00
16.00
14.00
12.00
10.00
8.00
6.00
4.00
2.00
0.00
2008
2009
3 months
Source: Government Debt Management
2010
1 year
2011
2012
10-11 years
How does public debt
market work?
Primary market: yields ↓
Capital
controls
Bank’s partial
nationalization
Market makers close to
Government
Secondary market: yields ↓
Domestic scenario:
few alternatives to public debt
Investors not allowed to
invest abroad
Effects (5): cheaper public debt on literature
• Huge attention (but Iceland is not the typical example in this
regard)
• Often related to financial repression (Giovannini and De Melo,
1993; Roubini and Sala-i-Martín, 1995)
• Empirical analysis: financial repression implies (Alesina et al.,
1993; Reinhardt and Rogoff, 2009):
– Public debt cost ↓
– Public debt stock ↑
Effects (6): capital controls and economic
recovery
• Iceland: capital controls sustaining financial delicate
equilibrium during incipient recovery
• This effect is not captured by analizing individual macro
variables
Iceland’s
“trilemma”
Viable banks
Ec. Recovery
Public accounts
sustainability
Cheap public
debt
Households
deleveraging
(other)
Capital controls
Costs
• Benefits not available  limited inflows, poor risk
management, sub-optimal saving allocation, unsensible
policies mantained
– Maybe: there are some costs (on the medium-long term)
– Sure: other costs (short-medium term) have been avoided
thanks to capital controls
– Tradeoff  ??
• Damages:
– Opportunity costs, evasion efforts (Forbes, 2006): more important
as long as capital controls turn out ineffective (it’s not the case)
– Corruption: always possible. Important ??
Liberalization challenges economic recovery
• Potential damages
– Capital flight
– Debt sustainability
– Economic recovery: “trilemma” equilibrium at risk
• Resistances: if the institutions are captured by capital control
bureaucracy (Dooley, 1995)  Uncertain
• Government’s will
– Explicit will to remove controls
– Incentives not to do it
– Tricky issue: uncertain scenarios, no guarantee of success.
When is the right moment to remove controls?
Final remarks
1.
Capital controls in Iceland: very particular case
2.
Difficult issue to address
•
•
3.
Still evolving
Literature: focused on countries not similar to Iceland
Have capital controls been useful?
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•
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Intrinsic value: policy space gained (Krugman, 1998; Grabel, 2003)
Diagnosis? SO FAR, quite useful in making feasible current
promising scenario
Costs? Sure (how important?), but…what about alternatives costs?
(Grabel, 2003)
4.
Uncertainties
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•
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Costs of financial crash delayed but not avoided?
Huge uncertainty, but…is there any certainty at all? (look at the EURO
area)
At least, capital controls have contributed to a better present scenario
“Lifting the restrictions on
capital outflows is one of
the most complex tasks
facing the Icelandic
authorities at present”
“The future evaluation of the “Icelandic model” will
depend in part on the success of this process”
Már Guðmundsson
Governor of Iceland’s Central Bank
Thank you
References
•
Aizenman, Joshua y Pablo E. Guidotti (1990). Capital controls, collection costs, and domestic public debt.
NBER Working Paper Series. Working Paper nº 3443. National Bureau of Economic Research. Cambridge.
Massachusets.
•
Aizenman, Joshua and Brian Pinto (2011b). “Managing Financial Integration and Capital Mobility: Policy
Lessons from the Past Two Decades”. World Bank Policy Research Working Paper 5786.
•
Alesina, Alberto, Vitorio Grilli y Gian Maria Milesi-Ferretti (1993). The political economy of capital controls.
NBER Working Paper Series. Working Paper nº 4353. National Bureau of Economic Research. Cambridge.
Massachusets.
•
Battilossi, Stefano (2003). Capital mobility and financial repression in Italy, 1960-1990: a public finance
perspective. Woeking Paper 03-06. Economic History and Institutions Series 02. Febrero de 2003.
Universidad Carlos III de Madrid. Getafe.
•
Dooley, Michael P. (1995). A surveyof academic literature on conrols over international capital transactions.
NBER Working Paper Series. Working Paper nº 5352. National Bureau of Economic Research. Cambridge.
Massachusets.
•
Edwards, Sebastian (1999). “How effective are capital controls?” Journal of economic perspectives, Volume
13, nº 14 – Otoño 1999 – 65-84.
•
Forbes, Kristin J. (2006). Capital Controls. Submission for Palgrave’s Dictionary of Economics, 2nd edition.
•
Giovannini, Alberto y Martha de Melo (1993). “Government revenues from financial repression”. American
Economic Review, 83, n. 4, 953-63.
•
Grabel, Ilene (2003). “Averting Crisis? Assessing Measures to Manage Financial Integration in Emerging
Economies”. Cambridge Journal of Economics 27 (3):317-336.
References
•
Guðmundsson, Már (2012). Reflections on the “Icelandic model” for crisis mangement and recovery. Már
Guðmundsson, Governor of the Central Bank of Iceland. Speech at an Adam Smith Seminar named: 2012
and Beyond. World Economic Prospects, in Paris on 7 March 2012. The Central Bank of Iceland. Reykjavik.
•
Guðmundsson, Már (2012b). Speech delivered at the 51st Annual General Meeting of the Central Bank of
Iceland, 29 March 2012. Már Guðmundsson, Governor of the Central Bank of Iceland. The Central Bank of
Iceland. Reykjavik.
•
Henry, Peter Blair (2007) “Capital Account Liberalization: Theory, Evidence, and Speculation,” Journal of
Economic Literature 45: 887-935.
•
Kose, M. Ayhan, Eswar Prasad, Kenneth Rogoff and Shang-Jin Wei (2006). Financial Globalization: A
Reappraisal. National Bureau of Economic Research. Working Paper n. 12484. Cambridge, Massachusetts.
•
Krugman, Paul (1998). “Saving Asia: it’s time to get radical”. Fortune. September 7, p.74-80.
•
Magud, Nicolas y Carmen M. Reinhardt (2006). Capital controls: an evaluation. National Bureau of Economic
Research. Working Paper n. 11973. Cambridge, Massachusetts.
•
Obstfeld, Maurice, Alan M. Taylor (2004). Global capital markets : integration, crisis, and growth. Cambridge
University Press. Cambridge
•
Prasad, Eswar, Kenneth Rogoff, Shang-Jin Wei y M. Ayhan Kose (2003). Effects of financial globalization on
developing countries: some empirical evidence. International Monetary Fund.
•
Reinhart, Carmen y Kenneth S. Rogoff (2009), This time is different: eigth centuries of financial folly,
Princeton University Press, Princeton, N. J.
References
•
Rodrik, Dani (1998). Who needs capital account convertibility? Contribution to a symposium edited by Peter
Kenen, to be published as part of a Princeton Essay in International Finance.
•
Roubini, Nuriel y Xavier Sala-i-Martín (1995), “A growth model of inflation, tax evasion and financial
repression”, Journal of Monetary Economics, 35: 275-301.