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What is the impact of a speculative attack under a fixed exchange rate regime? What is...

  1. What is the impact of a speculative attack under a fixed exchange rate regime? What is the impact on capital flows?
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Speculative attack occurs in case of fixed exchange rate regime. If investors somehow come to know that central bank of country does not have enough foreign exchange reserve to support fixed exchange rate. In such situation, investors will sell currencies and buy foreign exchange. It will reduce capacity of central bank to maintain fixed exchange rate. Eventually, central bank shall be compelled to adopt floating rate of exchange.

Initially, there will be outflow of currencies due to speculative attacks but when currency is allowed to float, investor starts converting foreign currencies into the domestic currencies thereby giving rise to the inflow of capital.

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