Problem
How Can Persistently Weak Currencies Be Stabilized?
• Point: The currencies of some Latin American countries depreciate against the U.S. dollar on a consistent basis. The governments of these countries could attract more capital flows by raising interest rates and making their currencies more attractive. They also could insure bank deposits so that foreign investors who invest in large bank deposits do not need to worry about default risk. In addition, they could impose capital restrictions on local investors to prevent capital outflows.
• Counterpoint: Some Latin American countries have had high inflation, which encourages local firms and consumers to purchase products from the U.S. instead. By reducing inflation, these countries could relieve the downward pressure on their local currencies. To reduce inflation, a country may have to reduce its economic growth temporarily. These countries should not raise their interest rates in an attempt to attract foreign investment, because they will still not attract funds if investors fear that large capital outflows will occur at the first threat of continued depreciation.
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