Q. What kind of policies would policy makers Central Bank (CB) consider with: an exchange rate system with a “fixed E system”, high export growth, a rise in inflow of capital in the past few years, a problem emerging with growth of exports are slowing down and most profitable opportunities are getting exhausted. Oh yea, and by the way there is an indication that capital flight is occurring?
Dialoguing on the subject, erroneously maintaining the dollar or failing to revaluate the currency could eventually lead to a financial crisis. If the Central Bank were to continue support a fixed exchange rate without any type of adjustment to reflect the diminishing export growth, there could eventually lead to a larger collapse than if the CB had simply revaluated earlier. By maintaining a fixed E with a slowing economy, the short term results may support such a move, employment will remain high and the interest rate low. The capital flight would be slowed due to the appreciating currency. If the revaluation was forced through market pressures such as extensive capital flight, or simply that revaluation was put off longer and longer, the expected impact on growth, or Y, would be substantially higher than if the CB had revaluated earlier. The domestic interest rate will also be pressured to increase. Although there may have been a slight recession, it would not lead to a full fledged financial crisis.