The ERM currency crises redirected attention towards proposals for regulating the foreign exchange market. In Discussion Paper No. 1061, Research Fellows Barry Eichengreen, Andrew Rose and Charles Wyplosz consider the argument for temporary capital controls as a means of achieving European monetary union (EMU). First they show that controls have historically been associated with significant differences in macroeconomic behaviour, especially in monetary policy. While such policy changes have not prevented speculative attacks, they have provided the breathing space needed to organize orderly realignments. Using data for 22 countries over 25 years, the authors show that capital controls have been associated with significant differences in the behaviour of such macroeconomic variables as budget deficits and monetary growth rates.

The authors next provide evidence on the channels through which speculative attacks operate, showing that bank lending to non-residents is a key transmission mechanism. Their evidence on the channels through which speculative pressures are transmitted indicates the appropriate nexus for intervention. Non-interest-bearing deposit requirements on lending to non-residents are proposed as a third-best route to monetary union. The authors also discuss political constraints associated with the Maastricht Treaty and suggest that these provide a justification for the selective use of deposit requirements.

Is There a Safe Passage to EMU? Evidence on Capital Controls and a Proposal
Barry Eichengreen, Andrew K Rose and Charles Wyplosz

Discussion Paper No. 1061, November 1994 (IM)