6.6 Real Interest Rates and International Capital Flows

Financial capital is mobile and chases the highest real return. When one country's real interest rate rises relative to others, foreign investors buy that country's bonds and other assets, capital INFLOWS. When its relative real rate falls, capital flows out.

Trace the full chain for a U.S. real-rate increase: capital flows in → the capital and financial account moves toward surplus → demand for dollars rises → the dollar appreciates → U.S. net exports fall, moving the current account toward deficit. The two accounts move in mirror, as Topic 6.1 requires.

This closes the loop on crowding out in an open economy: government deficits raise real interest rates, which attract foreign capital and appreciate the currency, so net exports fall too. The inflows also add to the supply of loanable funds, partially softening the rate rise.