Hot Money

In this revision video, we cover an important concept in the global financial system – namely inflows and outflows of hot money

Hot money is money (or financial capital) that flows freely and quickly around the world looking to earn the best rate of return.

Hot money might be invested in any financial asset whose value is expected to rise such as property or shares, or simply saved in commercial bank accounts of a currency offering the best post-tax rate of interest.

Why can hot money be significant for a country’s economy?

1. May help a central bank to influence a currency in a managed floating system
2. Inflows of hot money (portfolio capital) can provide commercial banks with extra funds to lend to finance business investment
3. Hot money flows can create excess liquidity in the economy perhaps causing a future asset boom (including share price bubbles)
4. Hot money tends to be volatile – (1) they can amplify exchange rate movements which then impacts on components of AD including exports (2) they can move out of a country quickly too (“cold money!)

"Hot money" refers to short-term investments or funds that are rapidly moved between countries or financial markets in search of the highest short-term return or interest rates. It typically refers to speculative capital that flows into or out of a country, taking advantage of interest rate differentials, exchange rate fluctuations, or other market opportunities.

Hot money is characterized by its high liquidity and quick mobility. Investors or speculators may move their funds swiftly in response to changes in market conditions or to exploit temporary profit opportunities. This movement of funds can be facilitated by modern electronic banking systems and global financial networks.

The term "hot money" can also be used to describe the potential risks associated with short-term capital flows. Sudden inflows or outflows of hot money can create volatility in financial markets and put pressure on a country's currency, leading to exchange rate fluctuations and economic instability. Governments and central banks often monitor and manage these capital flows to maintain stability in their economies.

Overall, hot money represents the short-term speculative capital that moves swiftly between countries or financial markets, seeking short-term gains based on interest rate differentials or market fluctuations.