Currency Crises Prompt Capital Controls, Not Greater Openness

Why This Question Matters

Thomas B. Pepinsky asks whether currency crises push governments toward opening their capital accounts to signal credibility to markets — a common claim in the literature — or whether crises instead provoke governments to restrict capital flows as a form of self-help. The answer reshapes how scholars understand the political consequences of financial turmoil and the conditions under which neoliberal reforms take hold.

How Pepinsky Tests the Argument

Pepinsky confronts the key empirical challenge that liberalization itself might cause crises by using instrumental-variables techniques to account for this reverse causality. The analysis draws on cross-national evidence from developing countries and assesses changes in capital account policy following episodes of currency instability. The study emphasizes identification strategies and robustness checks to isolate the effect of currency crises on capital-account policy choices.

Key Findings

• Using instrumental variables to address endogeneity, Pepinsky finds that currency crises are robustly associated with subsequent capital account closure rather than liberalization.
• The relationship holds across specifications and robustness tests, suggesting that crises often trigger governments to tighten controls on capital flows as a defensive policy response.

Why It Matters for Theory and Policy

These results challenge a standard narrative that crises create openings for market-oriented reforms; instead, currency crises can produce retrenchment in capital mobility. The findings prompt a reevaluation of claims about critical junctures driving neoliberal policy change and have implications for how international actors and domestic policymakers interpret and respond to financial crises.

Takeaway

Pepinsky's study provides evidence that currency crises frequently lead to increased capital-account restrictions in developing countries, recasting debates about the political fallout of financial instability and the dynamics of policy reform.