Question

Studies indicate that net exports and net capital outflows tend to be equal.

a) Why do net exports and net capital outflows tend to be equal? How does an increase in the price level change interest rates?

b) How does this change in interest rates lead to changes in investment and net exports?

Answer 1

(A). Always equal because every international transaction is an exchange. When a seller country transfers a good or service to a buyer country, the buyer country gives up some asset for these goods or services and the value of that asset equals the value of goods and services sold. Hence, the net value of goods and services sold by a country must equal the net value of assists acquired. The more you expect money to devalue, the more interest compensation will be demanded.

(B). when price level increases the power of money on hand and in banks declines and people feel less wealthy and has less to lend which in turn causes interest rate to rise. This leads to discourage in spending on investment goods so that the aggregatequantity of goods and services demanded decreases. As interest rates increases, supply of dollars in market for foreign-currency falls as people wish to purchase fewer foreign assets which make dollar appreciate which decreases net exports.