VoxEU Column EU institutions Macroeconomic policy

The capital controls in Cyprus and the Icelandic experience

Cyprus has imposed temporary capital controls. This column sheds light on how temporary and how damaging they are likely to be, based on Iceland’s experience. The longer controls exist, the harder they are to abolish. Icelandic capital controls, which have been ‘temporary’ for half a decade, deeply damage the economy by discouraging investment. We can only hope the authorities that created the chaos in the first place realise that temporary really needs to mean temporary.

The Cypriot government, European authorities and the IMF have concluded that capital controls are the best way to prevent a total collapse of the Cypriot financial system. Motivated by the obvious fear that anybody with money left over in Cyprus will seek to take their money out as soon as possible, temporary capital controls are to be put in place to prevent this. We are told that they will be limited in scope and temporary. Hopefully, for the Cypriots’ sake, that is correct.

Another European country was forced to implement `temporary’ capital controls in its crisis – Iceland, as discussed here on Vox (Danielsson and Arnason 2011).

The Icelandic government, its central bank and the IMF considered the controls necessary because so many foreigners, and the occasional wealthy Icelander, had lost faith in the economy and only wanted to take their money out. While such individuals were considered misguided, their exit would have had disastrous consequences. Hence it was thought necessary to `temporarily’ prevent capital outflows.

The authorities said at the time the controls would be temporary and limited in scope – lasting a few weeks or, at worst, a month or two. Half a decade later, the capital controls are still in place and getting more and more restrictive.

This was the second time Iceland had implemented `temporary’ capital controls. The first time it did so, in the 1930s, led to the controls being in place until 1993. This is in line with the historical evidence; once capital controls are imposed, they are really hard to abolish, and a temporary arrangement usually ends up being permanent.

The reason is that when a country implements capital controls, it signals the authorities have lost control over the economy, needing to employ desperate measures. That is does not exactly build confidence, so anybody with money will seek to abandon the sinking ship as quickly as they can, persisting in that desire until things look better. While the controls last, however, it is unlikely that things will look better because the abolition of the controls can become a necessary condition for improving economic conditions. This is why the official pronunciations on the duration and the scope of the capital controls in Iceland were always too optimistic.

The Icelandic capital controls have proven to be highly damaging for its economy; investment has collapsed and is just about the lowest in Europe at 14.4% of GDP in 2013, compared to the EU average of 18%. The reason is that foreign direct investment almost completely dried up and any domestic residents with money left over prefer to keep their funds liquid, ready to be exported when an opportunity presents itself. Domestic investment is not compatible with that objective.

While the capital controls are meant to prevent outflows of money, those wanting to take money out will find a way, legally or otherwise. The end result is a cat-and-mouse game between the government and capital owners, one where the authorities are at a disadvantage. This leads to ever-tightening of the controls. Meanwhile, the conditions are ripe for corruption, anybody with access to the licensing for capital exports stands to benefit. Having the central bank in charge of licensing for the export of capital, as is the case in Iceland and Cyprus, can only undermine its integrity.

The capital controls violate EU laws regarding the principle of the four freedoms – free movement of goods, capital, services, and persons. The Cypriot capital controls will violate at least two of these principles, just as the Icelandic ones do. The free movement of capital is prevented by the controls.

Even more seriously, it violates the free movement of persons, and hence the human rights of people subject to capital controls. If one cannot sell one’s house and use the money to buy a house abroad, movement across borders is restricted. If one cannot take money out of the country, the ability to travel and live wherever one wants in the EU is restricted. Trying to restrict outflows to those for only 'legitimate' reasons will not work. One can always find someone with a legit reason to export money.

The fact that the European authorities stand so ready to abandon their fundamental principles in order to address a temporary, and relatively small, economic problem is a cause for concern.


Because it was an emergency situation, a temporary, drastic solution was needed – Icelandic capital controls. It has now been five years, and the Icelandic authorities are openly discussing keeping the capital controls for decades to come. The controls have been holding back Iceland’s economic recovery, causing Iceland to become relatively poorer every day.

The longer a country maintains capital controls, the harder they are to abolish. The economy adapts to them and they become a part of the permanent landscape.

In the Icelandic case, it is easier to enforce the capital controls because it only involves the exchange of one currency for another. In the Cypriot case, they entail an intrusive government intervention in all aspects of economic life, up to and including searching those seeking to leave the country, in case they might be hiding some euros on their person. This can only further encourage those who want to take the money out to do so.

It would have been much better for the IMF, the EU and the Cypriot government to accept the short-term outflow of money after the banks opened; this would have meant a much quicker return to normality. Instead, it will become harder and harder to lift the controls as economic uncertainty is likely to continue increasing.

We can only hope for the sake of the Cypriots that the capital controls are truly temporary, that the authorities that created the chaos in the first place realise that temporary really needs to mean temporary.


Danielsson, J and R Arnason (2011), “Capital controls are exactly wrong for Iceland”, VoxEU.org, 14 November.
Eurogroup (2013). Eurogroup statement on Cyprus, 25 March.

7,874 Reads