Answer to Question #220220 in Macroeconomics for Jeff

Question

How would increased political instability in a country likely affect capital inflows, the domestic real interest rate, and investment in new capital goods? Show graphically and explain. 

Answer 1

When there is trade between countries, then there is imports and exports of goods and services. People invest in assets and financial instruments in foreign countries as well. This leads to inflow and outflow of capital.

When there is increase in political instability, then it means that any investment in that country is now riskier. So, capital inflow will decrease and supply curve will shift to it’s left as shown in the diagram above. So, there will be decrease in savings and domestic investment and there will be increase in real interest rates.