The Relationship between Currency Crisis and Capital Control: An Early Warning Model of Currency Crisis

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Nasiri Narges; Tayebi Seyed Komail

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Journal Paper

Paper Information

Journal: Iranian Journal of Economic Research Year:2022 | Volume:27 | Issue:91 Page(s): 51-109

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Title

The Relationship between Currency Crisis and Capital Control: An Early Warning Model of Currency Crisis

Author(s)

Nasiri Narges | Tayebi Seyed Komail | Issue Writer Certificate

Keywords

Capital ControlQ4

Currency CrisisQ4

Early Warning SystemsQ4

Bayesian Averaging ModelQ4

Abstract

The purpose of this paper is to specify an early warning system for Currency Crisis and to investigate the role of Capital Control together with other warning indicators in the crisis. Increasing mobility of capital and liberalization in international financial flows is one of important dimensions of globalization, which has significant benefits to many countries worldwide. However, due to negative impacts on exchange rates as well as currency crises, financial liberalizations followed by some Latin American and Southeast Asian countries raised concerns in the last decade of the twentieth century. Hence the question: can Capital Control play a role in preventing or exacerbating the Currency Crisis? This study evaluates the relationship between Capital Control index and Currency Crisis and also examines the role of this variable as a warning indicator. Since the main application of the Early Warning Systems is crisis forecasting, the purpose is to model the early warning indicators of Currency Crisis using Bayesian averaging method. To achieve this, 70 variables were examined for 60 countries during the period 1975-2019, both in floating and non-floating exchange rate systems. The results showed that Capital Control has a significant effect on reducing the occurrence of Currency Crisis, also different Capital Control indicators do not have the same warning power. In addition, different currency systems are effective in changing the power and rank of warning variables, especially for the use of Capital Control index.

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