MAcro CHAPTER 6.6:

CHAPTER SUMMARY

When a country is an attractive place to invest, it will experience inbound capital flow - people will want to invest more money in the country's stocks, bonds, and savings accounts - their financial markets. For this chapter, this is what we mean when we say "invest" - this is not the same thing as business investment, which is when businesses purchase physical capital. A country can attract capital flow for a few reasons, but we will focus on the impact of interest rates.

When a country has high interest rates, more capital will flow into that country because investors want to collect that high interest. When a country has very low interest rates, it will experience outbound capital flow because people don't want to invest their money just to collect 0.1% interest per year.

So, let's look at what happens when the US pursues expansionary monetary policy:

• The Fed lowers the Federal Funds Rate, causing a decrease in interest rates

• Foreign investors pull money out of the USA (capital outflow) to invest in other countries

• Supply of USD increases since foreign investors try to sell them, while demand for USD decreases

• The exchange rate will fall, causing the USD to depreciate

• The USA will start to export more goods and import less goods

The opposite will occur when the US pursues contractionary monetary policy.

These inflows and outflows also impact the loanable funds market. When a country attracts more investment and inbound capital flow increases, the supply of loanable funds increases, causing real interest rates to fall and the quantity of loanable funds to increase, as seen here:

The inflow of loanable funds also increases the country's financial and capital account balances.

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