Final answer:
In equilibrium, desired international lending by one country equals desired international borrowing by the other, and the correct answer is A. Borrowing; capital inflow. The equilibrium interest rate aligns with the matching current account balance and capital inflow balance between these two large open economies.
Step-by-step explanation:
In a world with two large open economies, in equilibrium, desired international lending by one country must equal desired international borrowing by the other country. The equilibrium real-world interest rate is determined by the point at which the current account balance of one country equals the capital inflow balance of the other country. Therefore, the correct answer is A. Borrowing; capital inflow.
When one country is engaging in international lending, it means that it is sending out more capital than it is receiving, resulting in a current account surplus. Conversely, the other country must be attracting more capital than it is sending out, which reflects a current account deficit and equates to borrowing on an international scale. The equilibrium interest rate is thus at the level where these current account and capital flow balances match.
Understanding the relationship between current account balances (comprised of trade balances and income flows) and capital flows is essential in grasping why in equilibrium, one country's excess international lending must correspond to another country's borrowing.