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Tide barriers

Capital controls would work better if there were some international norms

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Preaching to the converted there. The greatest disagreement here, is that bad investments cause far more damage than just nominal shocks.

Central banks can compensate for nominal shocks (though they really need to improve the mechanisms used for achieving this too).

But NGDP targets do not resolve the bigger underlying problem: if many businesses a base their investment activity, staff training, recruitment, borrowing, marketing and product development with a particular set of expectations, and if that set of expectations is badly disrupted, then there will be an inevitable surge in bankruptcies, unemployment, bad debts and human misery.

The nominal demand effect can be somewhat compensated for. But while that helps a little, it doesn't really stop the suffering.

That's an RBC argument that doesn't work when discussing nominal factors. And the prices of assets are most certainly nominal factors.

If bubbles cause their damage by inflicting pain on real GDP through a nominal shock then a central bank that counterbalances the nominal shock with timely and appropriate action will eliminate the threat of bubbles -- nominal shocks in the short term -- entirely.


Timely and appropriate action by the Fed prevented employment losses on any scale for well over a year from the housing collapse (and concomitant nominal shock).

Lack of timely and appropriate Fed action did not prevent employment losses from the financial collapse (and concomitant nominal shock). Had the Fed acted to counter the nominal shock, no losses.

:End Examples

From these examples we can conclude that nominal shocks exist, that they cause damage on the real economy and employment, and that they can be prevented entirely by the monetary authority. We have further proof from the Great Depression and other periods.

You can argue that under an NGDP level target regime certain asset classes could receive excess capital investment and I'd absolutely one hundred percent agree with you. You could even argue that that would slow the growth of real GDP over the long term and I'd agree with that too. And even that inflation caused by failures on the supply side cannot be solved by the monetary authority. Again, full agreement here! But those are different problems. Short term nominal shocks caused by nominal changes in asset pricing (aka bubbles aka bubz) can be prevented entirely by action from the monetary authority.


Financial crisises are caused by high debt rather than temporary capital movements.

Some countries have restrictions on the repatriation of capital. But what is wrong if a foreign investor sells a factory or a hotel and pulls out? Some people may be happy that locals get to buy valuable assets for low prices.

Yes - bubbles are a serious problem even with NGDP targeting.

If an asset class is persistently miss-priced (because risks are not perceived), and if there is a large volume of new investment in this class, then enormous value will be added in the real economy (a big chunk of measured GDP will be in the creation of these assets).

When risk is perceived/ realised and prices adjust, that investment activity stops - wiping out a big bit of real GDP.

Now, the nice part of NGDP targeting is that it would respond with brief controlled monetary expansion & inflation. Insofar as some of the inflation passes through to the income of people loaded with bad debt, it makes debts easier to handle. Insofar as inflation supports real price & wage adjustments to life employment, some of the resources & workers that were hurt by the collapse of the asset bubble will find employment again even in the short term.

Nonetheless, collapse of an asset bubble has destroyed measured real economic activity and produced a chunk of inflation and increased unemployment.

NGDP beats conventional inflation targeting in the short run, and is equivalent in the long run. So NGDP easily wins. Yet it isn't perfect - NGDP is not the end of boom and bust. (To be fair, the Soviet Union had recessions too, and so did ancient Rome; recessions are just a consequence of the lumpiness of investment activities in any human society.)


This sounds like a very weak analysis on the part of the IMF - which is obviously disturbing.

There are different kinds of capital flow, not all of which share the properties of "hot money".

The real hot money problem, is the international purchase of short term bonds & bank securities (e.g. sovereign debt, debts of mining operations, securitised mortgages, etc). When crisis hits and home preference dominates (fear of unknown unknowns), that hot money flows home (and to safe havens) - it becomes impossible for government, firms or banks to refinance all that short term debt (foreign creditors simply exit on maturity, and there aren't the domestic savings to support refinance). That triggers either a massive recession with some combination (some or all) of collapse in private investment, collapse in consumption, increase in savings, deep fiscal austerity and accelerating inflation (trade off between these hells - often all at once).

So, the problem is short term bonds.

If international capital flow takes the form of equity investment, then we don't have the same problem. Foreign creditors can't just exit at maturity - they have to independently find a buyer and pass on the asset. So there is no refinance risk. Foreign capital flight might constrain the equity finance of new investment; foreign capital flight might make it difficult for domestic savers to liquidate their own equity investments. But foreign capital flight from equity cannot in itself trigger a drastic increase in savings and collapse in demand (not of the kind that impossible refinancing requirements would impose).

Similarly, long term bonds (with only a small proportion maturing annually) are quite safe for international investment flows (up to a pretty large proportion of GDP). If maturing 10 year bonds held by foreign investors sum to 5% of GDP, that's probably manageable. So perhaps up to a net 50% of GDP owed to foreigners in the form of long term bonds really isn't a hot money problem either.

Short term lending and short maturity bonds/ assets should be restricted to a small proportion (say, 10%) of all international capital flows. The rest should be long term bonds and equity. That's the kind of capital controls we should demand as economists - solve the actual problem, without creating opportunities for rent seeking, and without creating barriers to the free investment & production of firms.

One caveat: this restriction isn't even necessary, if we can eliminate surges in home preference. That's especially relevant to the eurozone - with an appropriate auditing framework, appropriate financial equity margins, a European resolution mechanism and a European deposit protection system, financial markets across Europe would remain liquid (and short term bonds easy to refinance). Europe doesn't really have the option of banning trading of 1 year Bunds, so I guess that leaves a banking union.

For the rest of the world, insofar as capital controls are deemed necessary, leave longer term length investment well alone - just restrict international trade in short maturity bonds.

This is not a Pen Name

Are bubbles a relevant worry in a world that has begun to broadly accept the merits of NGDP level targeting? Surely if the nominal collapse caused by the evaporation of the bubble is averted with prompt action from the monetary authorities in line with their stated goals re: NGDP, then there can be no impact on the economy as a whole. Wage contracts will end up renegotiated, workers will shift sectors and capital will be redeployed without measurable impact on the economy. And the sudden lack of viable bubble assets without massive losses to the economy as a whole would mean a simple redistribution of capital from the bubble sector to the non-bubble sectors, improving their rate of growth.

Furthermore, if the primary impact of capital inflows is on nominal factors and such factors are totally controlled by the central bank, wouldn't it be plausible to assume that the central bank could simply assert dominance should capital inflows become threatening? Surely no sane investor would attempt to oppose a central bank that had declared a ceiling (rather than a floor) on the value of its currency! And wouldn't this explicit and far more targeted declaration have similar impact to capital controls sans the potential for creating vested interests opposed to its removal?

In short I can't see any merit in using capital controls over to monetary ones with the same purpose. So long as the central bank is explicit about what it will and will not tolerate there should not even be an inflation issue. A few misguided souls might attempt to fight back, the bank would slap them down and that would be the end of it. No need for mass purchases, as only an idiot would bet against the printing press.

Not entirely following what you're trying to say.

No government design can achieve a perfect capital allocation. No market can achieve a perfect capital allocation either - because market participants are acting on very imperfect information (with further complication from adverse selection, moral hazard, etc). There will always be very bad mal-investments.

Obviously, bankruptcy and resolution is necessary and good.

Yet when bankruptcy pervades the financial sector, pulling down Lehman Brothers & Bear Stearns and leaving bid-ask spreads a mile wide, businesses across the economy are forced to cut investment and build working capital.

No monetary or fiscal expansion could compensate for that (help a little perhaps - but not much).


On your distinction between nominal and real shocks, I'm a bit lost too. Why the absurd claim that "nominal shocks never clear"? Obviously, in the long run, the economy adjusts to monetary shifts just as it does to shifts in other fundamentals. There isn't much empirical evidence for sticky prices in the eurozone, Switzerland, Norway or Japan (where nominal wage and price cuts have been widespread). Nominal price rigidities are overdone in the literature. Where nominal movements matter much more, is in the implications they have for debt servicing.

On debt servicing, nominal shocks have the potential for extreme debilitation, creation of bad debts, and wide financial contagion/ depression. But so do shifts in fundamentals and "real shocks".

When financial markets are dry and firms are forced to save en masse, no central bank monetary expansion will be good enough.

Most of what you're saying should have occurred after the housing bust -- a nominal shock -- did not occur until a nominal shock was allowed to hit the economy -- financial bust. At which point those things happened.

Can people still go bankrupt even if nominal shocks are prevented by central banks? Yes. That's a feature, not a bug, of the system. Bankruptcy is a critical element of a functioning economy and reflects the system's clearing/restructuring of a person's debts so that they can continue with their life.

If businesses are investing excessively in a single area to the detriment of other areas, then there is a 'real side' problem that can be solved by better market design on the part of the elected government. It cannot cause immediate unemployment -- so long as a nominal shock is prevented -- for the simple reason that markets are functioning at equilibrium, albeit poorly. It might be a BAD real equilibrium that lowers real growth over the long term, but it is a STABLE bad real equilibrium. UNLESS a nominal shock occurs OR a real shock occurs! OR both as in the 70s.

Asset PRICE declines are a nominal shock that have a nominal remedy. All the wood on planet earth disappearing? Real shock that nominal action by the monetary authority cannot solve. Real shocks are very very obvious, nominal shocks are harder to observe.

The tl;dr is as follows: equilibriums can only be disrupted by shocks. If shocks are prevented on the nominal side then only real shocks are left. If we do not observe a real shock either, then we are in an equilibrium. Nominal shocks "never" clear up on their own due to sticky wages/prices. Real shocks sometimes do (OPEC let go of the developed world's jiggly bits eventually, right?).

"If bubbles cause their damage by inflicting pain on real GDP through a nominal shock" - wrong.

Forget aggregates. Expenditure volumes on new investments is booked as value added and counted in GDP. If in reality that investment does not achieve the return predicted by investors, then measured GDP had been falsely inflated for years.

As this investment activity contracts, that means a reduction in measured output. And that reduction is real, causes unemployment, causes bankruptcies, and is often asymmetric (hurting some geographic locations much more than others).

NGDP is better than inflation targeting because it does maintain aggregate values at a level where they can better allow debt servicing and fuller employment. But at a more granular level, in the real economy, where distribution activity patterns & spending patterns matter, we can still have some large mal-investment bubbles and some nasty recessions when they pop.


Even if there were a theoretical case to be made for capital controls, the chances of it being implemented in the "correct" way by the applicable political systems are so small as to make this unworthy of further discussion. No sense trying to clear such a "high bar" if you are a paraplegic.

Steve Allen317

America had a similar problem. The English started a land specuation run on American property, prompting a large influx of capital into America. The result was a land speculation "bubble" that when it burst, sent America and Britian into a recession.
The year was 1789.
The vast influx of capital into America speculating on housing values created a "bubble" that when it burst, sent America, and virtually the world into a recession.
That year was 2008.
Somehow "economists" seem to think inflows and outgos of capital investment causing economic bubbles is a "new concept". Any "speculation" on any "industry or market" creates a "bubble". An artifically created value that benefits those who "start" the speculation run, and leaves those who "invest" holding worthless "paper". It's an old con and people still fall for it.


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