Emerging markets frequently get hit by the following two effects when they have a financial crisis:
A)a decrease in the real interest rate and in the real exchange rate.
B)capital flight and a falling real interest rate.
C)an increase in the real interest rate and a depreciation of the real exchange rate.
D)a surge in net capital inflows and rising inflation.

Question

Quizplus · Accepted Answer

During a financial crisis, investors usually withdraw their investment and this leads to a decrease in demand for the currency of the affected country, depreciating its exchange rate. At the same time, the increase in the perceived risk of investing in the country leads to an increase in the required rate of return by investors, which makes borrowing more expensive and increases the real interest rate. Therefore, the emerging market experiences an increase in the real interest rate and a depreciation of the real exchange rate.

Emerging Markets Frequently Get Hit by the Following Two Effects