Ummm...
Expansionary fiscal policy with unchanged monetary policy is much more likely to lead to upward pressure on the currency and an *inflow* of capital. Consider the U.S. from 1980-1986. What puts downward pressure on the currency--and generates the potential for capital flight--is when expansionary fiscal policy is combined with a loosening of monetary policy as well, and with expectations that the government's budget deficit is going to be financed by printing money.
Moreover, downward pressure on your currency is not necessarily a bad thing. A depreciated currency (a) reduces the power of your elites to purchase foreign-made luxuries, and (b) improves the competitiveness and expands the markets of your export industries.
Downward pressure on your currency can be a very bad thing under three circumstances: (i) you are Brazil in 1998-9, and have relied on a fixed peg of the real against the dollar in order to lend credibility to your efforts to stamp out hyperinflation, (ii) you are Mexico in 1994-5 (or Southeast Asia in 1997-9) and have borrowed or allowed your private sector to borrow very large sums denominated in dollars, or (iii) you are Mitterand in 1981-3 and regard a weakening of the franc against the mark as a national humiliation.
My view is that developing countries should...
...not regard a weakening of their currencies as national humiliation.
...not allow their private sectors to borrow abroad in harder currencies without heavy taxes and reserve requirements.
...not make pegs of their exchange rates key parts of their anti-inflation programs.
...try to encourage inflows of foreign direct investment--for inflows of foreign direct investment are one of the best ways to transfer technology from the industrial core to the periphery, and the technology gap between the industrial core and the periphery is now wider than it has ever been before.
...try to encourage inflows of home currency-denominated portfolio investment in the context of a floating exchange rate, for access to foreign capital on cheap terms when New York is feeling bountiful allows one to cut perhaps a generation off the process of industrialization--or so the nineteenth-century U.S., Australia, and Canada found back when London was feeling bountiful.
I could be wrong: successfully managing an international economy of large-scale capital flows requires a greater willingness to adopt floating exchange rates and better-funded international institutions than we have seen in the 1990s. Benefits from access to the worldwide pool of savings to accelerate industrialization need to be weighed against the costs of potentially large international business cycles driven by currency crises.
But why bother trying to think about the--complex--truth when you can propound a--simple--half-truth instead?
Brad DeLong
-- -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- "Now 'in the long run' this [way of summarizing the quantity theory of money] is probably true.... But this long run is a misleading guide to current affairs. **In the long run** we are all dead. Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is long past the ocean is flat again."
--J.M. Keynes -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- J. Bradford De Long; Professor of Economics, U.C. Berkeley; Co-Editor, Journal of Economic Perspectives. Dept. of Economics, U.C. Berkeley, #3880 Berkeley, CA 94720-3880 (510) 643-4027; (925) 283-2709 phones (510) 642-6615; (925) 283-3897 faxes http://econ161.berkeley.edu/ <delong at econ.berkeley.edu>