Consider a small open economy that takes the world real interest rate as given. Suppose the world real interest rate is less than the country’s autarky real interest rate. Which of the following is TRUE?Group of answer choicesDomestic saving exceeds domestic investmentThere is capital outflowThere is excess demand for capitalNone of the other options
Question
Consider a small open economy that takes the world real interest rate as given. Suppose the world real interest rate is less than the country’s autarky real interest rate. Which of the following is TRUE?Group of answer choicesDomestic saving exceeds domestic investmentThere is capital outflowThere is excess demand for capitalNone of the other options
Solution
In a small open economy that takes the world real interest rate as given, if the world real interest rate is less than the country’s autarky real interest rate, it means that it is cheaper to borrow money on the international market than it is domestically.
This situation would lead to capital outflow, as domestic investors would seek to take advantage of the lower interest rates available abroad. They would borrow from the international market and invest in their home country, leading to a net outflow of capital.
Therefore, the statement "There is capital outflow" is TRUE.
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