Inter-American Development Bank

In the aftermath of the global \u85nancial crisis, a new policy paradigm has emerged in which old-fashioned policies such as capital controls and other government distor-tions have become part of the standard policy toolkit (the so-called macro-prudential policies). On the wave of this seemingly unanimous policy consensus, a new strand of theoretical literature contends that capital controls are welfare enhancing and can be justi\u85ed rigorously because of second-best considerations. Within the same the-oretical framework adopted in this fast-growing literature, we show that a credible commitment to support the exchange rate in crisis times always welfare-dominates prudential capital controls as it can achieve the \u85rst best unconstrained allocation. In this benchmark economy, prudential capital controls are optimal only when the set of policy tools is restricted so that they are the only policy instrument available. JEL Classi\u85cation: E52, F37, F4