I am currently reviewing some stuff on capital flight and self-fulfilling crises.
In this scenario, investors generally think that a low availability of reserves could imply that the central bank may not be able to hold a fixed exchange rate. Consequently, investors quickly convert their domestic assets into foreign assets.
Given that this implies that the money supply decreases (as currency in circulation reduces), shouldn't this automatically increase interest rates? (Under IS-LM framework, a decrease in money supply increases interest rates). As a result, domestic assets should automatically become more valuable, thus fixing the problem naturally. Is there a problem in this line of reasoning?