If the real interest rate in country A is higher than the real interest rate in country B, capital will flow into country _______________, causing the real interest rate in country A to ________________.

Question

BlackTom AI · Accepted Answer

To approach this question, I’ll lay out how differential real interest rates affect capital flows and then apply it to the given scenario.
Option a: 'a. A; increase' would imply that when A’s real rate is higher, capital flows into A and pushes A’s rate up further. In macro/mosey terms, investors would move funds to the higher return country, but that additional demand for funds in A would actually raise, not lower, A’s real rate—contradicting the typical adjustment path toward equalization. This makes option a implausible.
Option b: 'b. B; cannot be determined' suggests ambiguity about the direction of flow or the effect on rates. However, standard theory of international capital flows with higher real rate in A predicts a clear direction: capital moves to A, reducing A’s rate and elevating B’s rate eventually. Therefore, b ignores the fundamental mechanism and is not correct.
Option c: 'c. B; increase' states that capital would flow into B and raise B’s rate. Since A has the higher real rate, investors would not preferentially move funds to B (the lower real rate country) in equilibrium; this contradicts the incentive structure of arbitrage across countries, so c is incorrect.
Option d: 'd. A; decrease' aligns with the logic that capital flows from countries with lower to higher real rates, i.e., from B to A, increasing demand for assets in A and thereby pushing A’s real rate downward toward the world rate, at least in the short to medium run. This matches the standard adjustment mechanism and is thus consistent with the scenario described.
Option e: 'e. B; decrease' would imply capital flows into B and lowers B’s rate, which is inconsistent with A having the higher real rate to begin with. If funds go to B, B’s rate would tend to rise (not fall) as capital leaves B, making e an incorrect depiction of the flow and rate change.
In sum, only the scenario where capital moves into the country with the higher real rate and that country’s rate falls fits the conventional capital-flow adjustments, while the other options conflict with the direction of move or the resulting rate changes. The reasoning above illustrates why A would attract capital and why A’s real rate would decrease, with the remaining options failing to match the expected dynamics.

If the real interest rate in country A is higher than the real interest rate in country B, capital will flow into country _, causing the real interest rate in country A to __.Single choice

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If the real interest rate in country A is higher than the real interest rate in country B, capital will flow into country _______________, causing the real interest rate in country A to ________________.Single choice