Answer to Question #264005 in Macroeconomics for Slim

Question

Initially, real interest rates in the United States, England, and Japan are all equal, at 5 percent. Then the central banks alter their policies, so that the American interest rate rises to 6 percent, the Japanese rate falls to 4 percent, and the British rate stays at 5 percent.

            a)   How would you predict that capital flows among the three countries would change?

            b)   Using supply and demand curves, show how the exchange rates are likely to change.

            c)   How do you expect the balance of trade in the three countries to change?

Answer 1

a) The capital flow of any country is depends on the interest rate determined by the central bank of that country. In this case when there is an increase in the interest of any country the cash flow is also decreases because peoples finds the cash at high level and it decreases the loan culture. As we can see that in US the interest rate is high so the cash flow is lower and vice versa for the Japan government.The cash flow for the Britain is constant as compared to old interest rate.

b) we can see that when there is an high interest rate then the demand for that currency would tends to decreases

We can see in the above diagram that the increases interest rate affects the cash flow between three countries. The demand curve are shifting as per the change in interest rates and it will affects the cash flow of the above countries. Though supply is the constant.

c) The balance of trade for three of the countries is can achieved by the same interest rate. we see that there is equal rate of interest then these three economies are in the balance of trade situation. But if one government tends to rise their rates the other government likely to cut the trade with that country. It will affects negative for both the countries. so , i think that if these three countries wants the balance of trade equal then the interest rates is wants to be the same.