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Initially, real interest rates in the United States, South Africa, and Mexico are all equal, at 6 percent. Then the central banks alter their policies so that the American interest rate rises to 8 percent, the South African rate falls to 4 percent, and the Mexican rate stayed at 6 percent.
Select one of the following:
| A. |
Capital will flow to countries with high interest rate. In this case, the United States will attract more inflows than South Africa and Mexico. South Africa will face maximum capital outflow.
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| B. |
Capital will flow to countries with the low-interest rate. In this case, South Africa will have the highest rate of capital inflow, Mexico will have the second highest, and the United States the least. The balance of trade will deteriorate for the country with the highest rate of capital outflow.
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| C. |
Capital will flow to the United States not because of the high-interest rate but because of perceptions of “safety and soundness”. The balance of trade will be indeterminate.
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| D. |
None of the above. |
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