Question

Other things the same, an increase in the U.S. interest rate causes U.S. net capital outflow to a. rise, so supply in the market for foreign-currency exchange shifts right. b. rise, so demand in the market for foreign-currency exchange shifts right. c. fall, so supply in the market for foreign-currency exchange shifts left.

Answer 1

An increase in the U.S. interest rates attracts more foreign investment, leading to a higher demand for U.S. dollars and a lowered supply due to reduced American investment in foreign bonds. This would actually cause net capital outflow to fall, and the exchange rate to appreciate due to these shifts in demand and supply.

Step-by-step explanation:

To ascertain the effect of an increase in the U.S. interest rate on its net capital outflow, we must consider investment incentives. A rise in U.S. interest rates, relative to other countries, increases the rate of return on investments in the U.S. This incentivizes more foreign investment into the U.S. and a higher demand for U.S. financial assets. Therefore, foreign investors will demand more U.S. dollars in order to make these investments, shifting the demand for U.S. dollars in the foreign exchange market to the right. Concurrently, a higher U.S. interest rate makes U.S. bonds more attractive, leading to Americans investing more domestically rather than in foreign bonds, causing the supply of U.S. dollars in the foreign exchange market to decrease. Overall, the net capital outflow would fall, an option not provided in the student's choices, but this effect can lead to an increase in the exchange rate due to higher demand and lower supply of U.S. dollars. The options provided by the student have the increase or decrease in supply but do not capture the comprehensive shift in the dynamic which is driven by a change in both demand and supply.

Answer 2

b. rise, so demand in the market for foreign-currency exchange shifts right.

Step-by-step explanation:

• An increase in the interest rates leads to a rise in the capital outflow as savings and investment lead to more net capital outflow.

• This is the movement of the assets on the company and is considered to be bad for the economy and leads to undesirable changes in the supply of the foreign currency as a shift in the demands of the consumers. This may result in political and economic instability.