6.5 Real Interest Rates and International Capital Flows

• What is the formula to calculate the real interest rate?

  $\text{Nominal interest rate} - \text{Inflation rate}$
• International capital flows are the movement of capital between countries
• Higher real interest rates attract foreign investment
• Differences in real interest rates are a primary driver of international capital flows
• Real interest rates are the nominal interest rates adjusted for inflation
• What does Foreign Direct Investment (FDI) involve?

  Gaining control of a business
• What happens to capital flows when real interest rates increase in a country?

  Capital inflows
• What is the effect of lower real interest rates on domestic borrowing costs?

  May increase borrowing costs
• International capital flows refer to the movement of capital between countries for investment, trade, and financial transactions
• When real interest rates increase, foreign investment is attracted, leading to capital inflows
• A higher real interest rate in a country leads to capital inflows
• Higher real interest rates attract capital inflows, causing the domestic currency to appreciate
• Capital outflows can increase import prices and inflation due to currency depreciation.


  True
• Steps of how exchange rates influence capital flows

  1️⃣ Exchange rates change

  2️⃣ Capital flows are influenced

  3️⃣ Domestic currency value changes
• International capital flows are not crucial for economic growth

  False
• Higher real interest rates can lead to currency appreciation

  True
• Why are international capital flows important for global integration?

  They facilitate economic growth
• Match the type of capital flow with its description:

  Foreign Direct Investment (FDI) ↔️ Investment to gain control of a business

  Portfolio Investment ↔️ Purchase of stocks and bonds without control

  Other Capital Flows ↔️ Loans, deposits, and trade credit movements
• If the real interest rate in the United States is higher than in Japan, Japanese investors may move their funds to the US.


  True
• If real interest rates in the US are higher than in Japan, the US dollar is likely to appreciate.

  True
• Currency appreciation resulting from capital inflows may lead to lower domestic interest rates.


  True
• Steps of how real interest rate changes affect capital flows

  1️⃣ Real interest rate changes

  2️⃣ Capital flows are influenced

  3️⃣ Exchange rate is impacted

  4️⃣ Domestic interest rates may change
• Steps of how capital flows impact the economy

  1️⃣ Capital flows occur

  2️⃣ Supply of capital changes

  3️⃣ Interest rates and growth are affected

  4️⃣ Exchange rate is influenced
• Order the types of international capital flows from most to least control-oriented:

  1️⃣ Foreign Direct Investment (FDI)

  2️⃣ Portfolio Investment

  3️⃣ Other Capital Flows
• Higher real interest rates in a country attract foreign investors because they offer better returns after accounting for inflation.


  True
• The exchange rate is a crucial factor influencing international capital flows.

  True
• Capital outflows can lead to currency depreciation
• Steps of how real interest rate differences affect capital movement

  1️⃣ Differences in real interest rates

  2️⃣ Capital flows occur

  3️⃣ Exchange rate is influenced

  4️⃣ Domestic interest rates may change