South Korea is growing relatively quickly and has begun to attract large inflows

Question

South Korea is growing relatively quickly and has begun to attract large inflows of foreign direct investment. While South Korea relishes the benefit of the inflows, it is concerned about the potential negative effects if the foreign investors pull out their investments quickly. One particular reason for South Korea to be concerned is that its banks have taken out large loans denominated in U.S. dollars and European euros from foreign banks. If the foreign direct investment is withdrawn quickly from South Korea, what will be the effect on each of the following?

Explanation / Answer

South Korea's money supply: INCREASE

Explanation: If FII withdraw the funds quickly from South Korea, there would be an excess of liquidity in the market. This would lead to a situation wherein too much money chasing too few goods.

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