ECON 3580 Lecture Notes - Lecture 17: Capital Flight, Aggregate Demand, Devaluation
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17 Jul 2018
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Devaluation: for devaluation to occur, the central bank buys foreign assets, so that domestic monetary assets increase and domestic interest rates fall, causing a fall in the rate return on domestic currency deposits. Domestic products become less expensive relative to foreign products, so aggregate demand and output increase. Official international reserve assets (foreign bonds) increase. Financial crises and capital flight: when a central bank does not have enough official international reserve assets to maintain a fixed exchange rate, a balance of payments crisis results. To sustain a fixed exchange rate, the central bank must have enough foreign assets to sell in order to satisfy the demand of them at the fixed exchange rate. Investors rush to change their domestic assets into foreign assets, depleting the stock of official international reserve assets more quickly: as a result, financial capital is quickly moved from domestic assets to foreign assets: capital flight.
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