Question

“Increase in net capital inflow will increase interest rates in the domestic loanable funds

market” – do you agree with this statement? Explain by drawing a diagram and

comment how you think investment will change if there is an increase in capital inflow.

Answer 1

The statement is not true.

An increase in net capital inflow will result in an increment in the loanable funds supply which leads to a reduction in domestic real interest rates as shown below:

If there is an increase in capital inflow, there will be more investment that will exceed the level of savings as a result of net importation of capital. This is as illustrated below: