Answer to Question #80431 in Macroeconomics for Tiyani Hlungwani

Question

7. Financial markets are not bound by borders and mobility of capital creates a single real interest rate. Why do interest rates then differ between countries?

Answer 1

The difference in interest rates in different countries is due to two main factors. First, the change in interest rates in the country affects, other things being equal, on the international movement of capital, especially short-term ones. In principle, an increase in the interest rate stimulates the inflow of foreign capital, and its reduction encourages the ebb of capital, including national, abroad. The movement of capital, especially speculative hot money, increases the volatility of balance of payments. Secondly, interest rates affect the operations of foreign exchange markets and loan capital markets. In carrying out transactions, banks take into account the difference in interest rates on the national and global capital markets with a view to extracting profits. They prefer to receive cheaper loans on the foreign loan market, where rates are lower, and place foreign currency on the national credit market if interest rates are higher.