If a country experiences a tremendous increase in the demand for loanable funds as many new infrastructure building projects are initiated, then the interest rate will
A) Rise, there will be a decrease in net capital outflow, and the real exchange rate will fall.
B) Rise, there will be a decrease in net capital outflow, and the real exchange rate will rise.
C) Fall, there will be an increase in net capital outflow, and the real exchange rate will rise.
D) Fall, there will be an increase in net capital outflow, and the real exchange rate will fall.

Question

Quizplus · Accepted Answer

An increase in demand for loanable funds leads to a rise in interest rates. This will make domestic bonds more attractive to foreign investors, leading to a decrease in net capital outflow. With a decrease in net capital outflow, the demand for foreign currency will decrease causing the real exchange rate to appreciate. Therefore, the correct choice is B.

If a Country Experiences a Tremendous Increase in the Demand