ECON help!!Which of the following statements best describes the resulting flow of capital?

Question

Suppose that the real interest rate in the United States falls, while interest rates in foreign countries remain unchanged. Also, assume that people's perception of the riskiness of assets remains unchanged.

Which of the following statements best describes the resulting flow of capital?

A. Net capital inflows increase in the United States.

B. Net capital inflows remain unchanged in the United States.

C. Net capital inflows decrease in the United States.

Answer 1

The answer is C. Rational investors seek the highest level of return for their money. Thus, if interest rates fall in the U.S. they will take money out of US savings accounts (for example) and put them in savings accounts paying higher interest rates in other countries.

Eventually this outflow of funds from the US to the other country would cause the exchange rates to change: the US dollar would depreciate against countries with unchanged interest rates.

This following equation must hold:

Rate of return (US) = Rate of Return (foreign) - xa (difference in exchange rate)

Answer 2

C. Net capital inflows decrease in the United States. - capital will tend to migrate to another countries for higher profits.