We lay down a standard macroeconomic model of a small open economy with a ﬁxed exchange rate and study optimal capital controls. We provide sharp analytical and numerical characterizations for a variety of shocks. We ﬁnd that capital controls are employed to respond to some shocks but not others. They are particularly effective to address risk-premium shocks that affect the interest rate differential foreign investors require in a particular country. We also discuss how the solution depends on the degree of nominal rigidity and the openness of the economy. We show that capital controls may be optimal even if the exchange rate is not ﬁxed in response to risk premium shocks or if wages, in addition to prices, are sticky. Finally, we compare the single country’s optimum to a coordinated world solution. Our results show a limited need for coordination. However, the uncoordinated solution features the same capital controls as the coordinated solution.
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