For various reasons, the international flow of capital will also have an impact on a country's economy. Because when capital flows into a country, the domestic money supply suddenly increases, so interest rates fall and domestic demand increases. In the case of full employment, the increase in demand will cause inflation. On the contrary, if capital flows out in large quantities, the domestic money supply will suddenly decrease, leading to an increase in interest rates, thus curbing the demand for consumer goods and private investment goods, which may lead to economic recession.
Under the fixed exchange rate system, if capital flows out, the capital account of the balance of payments will deteriorate. In order to maintain the exchange rate, the domestic economy must be tightened to reduce the deficit. Therefore, the level of domestic demand will decline and the economy will enter recession. If it is an adjustable pegged exchange rate system, when capital flows out, people may expect the currency to depreciate, thus further strengthening the demand for foreign currency. If the monetary authorities want to maintain the exchange rate, they need to use foreign exchange reserves. If this reserve is enough to maintain the country's current exchange rate, and the country's foreign exchange reserves are limited, it is difficult to maintain the stability of the current exchange rate, capital outflow may trigger financial speculation. When the country's reserves are exhausted, it will be forced to give up maintaining the current exchange rate, thus completely losing its ability to maintain the exchange rate and having to float its currency. This financial crisis may further affect the normal credit relationship in the economy, thus further causing the collapse of credit relations, and then leading to the chaos of the whole economic operation and economic crisis. From the perspective of foreign exchange speculation, some speculators may speculate because it is difficult for countries to maintain the current exchange rate, so international capital flows have the greatest impact on those countries that are difficult to maintain the current exchange rate.
On the contrary, the floating exchange rate system can cushion the impact of capital flows. Because capital outflow will lead to the deterioration of the balance of payments. At this time, the devaluation of the country's currency will increase the cost of foreign currency exchange and play a role in curbing capital outflows. At the same time, currency depreciation can also encourage commodity exports, curb commodity imports, and alleviate the impact of capital outflows on the normal operation of the national economy. On the other hand, the inflow of capital will lead to a surplus in the balance of payments, which may cause inflationary pressure on the country. Under the floating exchange rate system, the appreciation of the local currency will play a role in restraining capital inflows. At the same time, currency appreciation will restrain exports and encourage imports, and the trade balance will tend to be in deficit, thus alleviating the pressure of further currency appreciation.
From the analysis of the influence of the above three external factors on the economy, we can see that when the influence comes from the outside, a country's floating exchange rate has a greater effect on economic stability than adopting a fixed exchange rate. Therefore, floating exchange rate has become an "automatic stabilizer" for a country to resist external shocks.
See the textbook P360-36 1 for the answer analysis.
Knowledge points of this topic: internal balance under floating exchange rate 356-362,