An increasing reliance on capital controls

Article Highlights

  • Historic experience suggests that bad economic times all too often spawn beggar-my-neighbor policies.

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  • The global economy is already facing difficult economic times, and there is every reason to believe it will get worse.

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  • The odds are high that the global economy is now entering a prolonged period of weak growth and high unemployment.

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Historic experience suggests that bad economic times all too often spawn beggar-my-neighbor policies. Sadly, the global economy is already facing difficult economic times. And there is every reason to expect that those bad economic times will get materially worse in the years that lie immediately ahead.

The European economic periphery is presently in a deflationary spiral as a result of excessively pro-cyclical fiscal policies within a euro straitjacket. This spiral is fueling a widespread anti-austerity political backlash in Europe, which raises the very real risk of a disorderly unraveling of the euro. Meanwhile, U.S. public finances are on a clearly unsustainable path; Japan is facing a ticking demographic time bomb that will highly complicate the financing of its government; and incipient political instability in China could place that country on a very much slower growth path than it has enjoyed over the past decade.

As Guido Mantega, the Brazilian finance minister, does not tire of reminding us, the industrial economies are already engaged in a global currency war in response to their sluggish domestic economies. The United States, the United Kingdom, and Japan are all resorting to aggressive quantitative monetary policy easing that has the effect of artificially cheapening their currencies. At the same time, the European Central Bank has vowed to do whatever it takes to save the euro, and China continues to manipulate its currency with a view to keeping it artificially undervalued. These trends have already forced emerging market countries such as Brazil that are faced with massive capital inflows to resort to inward capital controls. Even the International Monetary Fund now concedes that there are circumstances where inward capital controls are justified.

The odds would appear to be high that the global economy is now entering into a prolonged period of weak economic growth and persistently high unemployment. In such circumstances one must expect an increasing reliance on capital controls, especially were one to get a disorderly unraveling of a major currency bloc as is the euro.

 

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About the Author

 

Desmond
Lachman
  • Desmond Lachman joined AEI after serving as a managing director and chief emerging market economic strategist at Salomon Smith Barney. He previously served as deputy director in the International Monetary Fund's (IMF) Policy Development and Review Department and was active in staff formulation of IMF policies. Mr. Lachman has written extensively on the global economic crisis, the U.S. housing market bust, the U.S. dollar, and the strains in the euro area. At AEI, Mr. Lachman is focused on the global macroeconomy, global currency issues, and the multilateral lending agencies.
  • Phone: 202-862-5844
    Email: dlachman@aei.org
  • Assistant Info

    Name: Emma Bennett
    Phone: 202.862.5862
    Email: emma.bennett@aei.org

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