[1] The following simple example illustrates the phenomenon of hot money: In the beginning of 2011, the national average rate of one year certificate of deposit in the United States is 0.95%.
The following description may help further illustrate this phenomenon: "One country or sector in the world economy experiences a financial crisis; capital flows out in a panic; investors seek a more attractive destination for their money.
In addition, once an estimate is made, the amount of hot money may suddenly rise or fall, depending on the economic conditions driving the flow of funds.
[3] However, large and sudden inflows of capital with a short-term investment horizon have negative macroeconomic effects, including rapid monetary expansion, inflationary pressures, real exchange rate appreciation and widening current account deficits.
These favorable asset price movements improve national fiscal indicators and encourage domestic credit expansion.
When global investors' sentiment on emerging markets shift, the flows reverse and asset prices give back their gains, often forcing a painful adjustment on the economy.
Although the emerging market countries welcome capital inflows such as foreign direct investment, because of hot money's negative effects on the economy, they are instituting policies to stop hot money from coming into their country in order to eliminate the negative consequences.