The domestic real interest rate in a small open economy is

Question

Quizplus · Accepted Answer

In a small open economy, the real interest rate is determined by the world real interest rate, as capital is highly mobile and investors can easily move their funds to countries with higher returns. The domestic interest rate must be equal to the world interest rate to prevent capital outflows or inflows that could disrupt the economy. Therefore, choice B is the correct answer. A is incorrect because the loanable funds market does not determine the interest rate in a small open economy. C is incorrect because the nominal interest rate includes inflation, while the real interest rate adjusts for inflation. D is incorrect because net exports do not determine the interest rate as they only affect the current account balance.

The Domestic Real Interest Rate in a Small Open Economy