Question

why are there capital outflows when interest rates increase?
whats the relationship between capital outflows and interest rates?

Answer 1

1. Higher interest rate (IR) contributes to higher borrowing rates. Around the same time, the return on investing money in a bank decreases. As a result, people are more likely to use their money in the form of savings or purchasing large ticket products such as cars and houses. As such, the money in circulation (capital flow) is rising.
Remember, however, that this presupposes that customers and investors have trust in the economy. This may also happen that, given a reduction in IR, capital flow does not increase unless customers are sure of spending. In fact, we presume that all other conditions do not change. Notwithstanding a decrease in IR, the capital flow may decrease if net exports decrease or government spending decreases.

2. Other things being equal, higher interest rates would draw more capital flows to the country, drive the balance of payments capital account in the direction of surplus and thus fund the movement of the balance of payments current account in the direction of deficit. Another way to see the cause and effect here would be to conclude that a country with a growing current-account deficit would need increasingly higher interest rates to fund the deficit, and that higher interest rates across the economy would ultimately slow down aggregate demand growth and thus correct the current-account deficit trend.The same would apply in the case of how lower interest rates impact the capital and current accounts, respectively.