What Is a Capital Control?

Capital control represents any measure taken by a government, central bank or other regulatory bodies to limit the flow of foreign capital in and out of the domestic economy. These controls include taxes, tariffs, legislation, volume restrictions, and market-based forces. Capital controls can affect many asset classes such as equities, bonds, and foreign exchange trades.

Capital Controls Explained

Capital controls are established to regulate financial flows from capital markets into and out of a country's capital account. These controls can be economy-wide or specific to a sector or industry. Government monetary policy can enact capital control. They may restrict the ability of domestic citizens to acquire foreign assets, referred to as capital outflow controls, or foreigners' ability to buy domestic assets, known as capital inflow controls. Tight controls are most often found in developing economies where the capital reserves are lower and more susceptible to volatility.

Key Takeaways

  • Capital control represents any measure taken by a government, central bank or other regulatory bodies to limit the flow of foreign capital in and out of the domestic economy.
  • Policies may restrict the ability of domestic citizens to acquire foreign assets, referred to as capital outflow controls.
  • Capital inflow controls limit foreigners' ability to buy domestic assets.
  • Critics believe capital control inherently limits economic progress and efficiency while proponents consider it prudent because they increase the safety of the economy.

The Debate Over Capital Controls

Capital controls are the subject of much debate. Critics believe they inherently limit economic progress and efficiency while proponents consider them prudent because they increase the safety of the economy. Most of the largest economies have liberal capital control policies and have phased out stricter rules from the past.

However, most of these same economies have necessary stopgap measures in place to prevent a mass exodus of capital outflows during a time of crisis or a massive speculative assault on the currency. Factors such as globalization and the integration of financial markets have contributed to an overall easing of capital controls. Opening up an economy to foreign capital typically provides companies with easier access to funds and can raise the overall demand for domestic stocks.

Real World Example

Capital controls are often established after an economic crisis to prevent domestic citizens and foreign investors from extracting funds from a country. For example, on June 29, 2015, the European Central Bank froze support to Greece during the European sovereign debt crisis.

Greece responded by closing its banks and implementing capital controls from June 29 through July 7, 2015, out of fear that Greek citizens would initiate a run on domestic banks. The monetary capital controls put limits on the allowable, daily cash withdrawals at banks and placed restrictions on money transfers and overseas credit card payments.

On July 22, 2016, Greece's Finance Minister reported that the country would ease its capital controls to increase confidence in Greek banks. The easing was expected to increase the amount of money held at Greek banks. According to The Guardian, Greece is putting the worst of the economic crisis behind it as it exits the bailout program. The government has loosened the limits on cash withdrawals and increased the allowance for business cash transfers.