If Canadian firms decide to invest more domestically at each interest rate, which statement would best describe the results?
A) The real interest rate decreases, the real exchange rate of the dollar depreciates, and Canadian net capital outflow decreases.
B) The real interest rate decreases, the real exchange rate of the dollar appreciates, and Canadian net capital outflow increases.
C) The real interest rate increases, the real exchange rate of the dollar appreciates, and Canadian net capital outflow decreases.
D) The real interest rate increases, the real exchange rate of the dollar depreciates, and Canadian net capital outflow increases.

Question

Quizplus · Accepted Answer

If Canadian firms decide to invest more domestically, it increases the demand for Canadian assets and decreases the demand for foreign assets. This leads to a decrease in the supply of Canadian dollars in the foreign exchange market and an increase in the demand for Canadian dollars, which causes an appreciation of the Canadian dollar. This appreciation of the Canadian dollar reduces net exports and therefore decreases net capital outflow. As a result, the real interest rate increases, and the real exchange rate of the dollar appreciates, leading to a decrease in Canadian net capital outflow.

If Canadian Firms Decide to Invest More Domestically at Each