Do high interest rates stem capital outflows?
Conventional wisdom posits that high interest rates stem capital flight and currency depreciation. Some have argued, however that the standard prescription exacerbates the problems. This paper set out a framework for evaluating the conditions under which an increase in domestic interest rates fails to reverse capital outflow. The possibility that high domestic interest rates might have unorthodox effects arises through a risk premium: If raising interest rates increases the possibility associated with default, the result can be a worsening of the country's capital account position.
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