CAPITAL CONTROLS, EXTERNAL IMBALANCES, SUDDEN STOPS AND CONTAGION By SEBASTIAN EDWARDS

In this paper I analyze whether restrictions to capital mobility reduce countries’ vulnerability to major external shocks. More specifically, I ask if countries that restrict the free flow of international capital have a lower probability of experiencing a sudden stop and being subject to contagion than countries that have a freer degree of capital mobility. I use three new indexes on the degree of international financial integration and a large multi-country data set for 1970-2004 to estimate a series of random-effect probit equations. I use these estimates to compute marginal effects of different indicators on the likelihood of a country facing a major external crisis. I also analyze the role played by other variables in determining the probability of experiencing a sudden stop, including large current account deficits; the exchange rate regime – fixed or flexible; holdings of international reserves; fiscal imbalances; world interest rates; and the degree of dollarization, among others. JEL Classification No: F30, F32