6.6

Real Interest Rates and International Capital Flows

AP Macroeconomics

Review: real interest rates drive capital flows

From loanable funds to the forex market

Step 1: Policy changes real interest rate

Step 2: Higher r attracts foreign capital

Step 3: Dollar appreciates

Step 4: Net exports fall

Three-market chain (critical for AP exam)

1234567891011121234567Quantity of Loanable FundsReal Interest Rate (%)r₁r₂SLFDLF₁DLF₂

Government deficit → DLF shifts right → r rises

123456789101234Quantity of DollarsPrice of $ (in foreign currency)e₁e₂D$₁D$₂S$

Capital inflows → D$ shifts right → dollar appreciates

The reverse: lower interest rates → capital outflows

Capital flows and the loanable funds supply

Worked example: Fed raises interest rates

Summary: how policies affect capital flows

AP Exam Tips

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Common Mistakes

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Unit 6 topics

Unit 6 overview6.1Balance of Payments Accounts6.10Economic Integration and Trade Agreements6.2Exchange Rates6.3The Foreign Exchange Market6.4Effect of Changes in Policies and Economic Conditions on the Foreign Exchange Market6.5Changes in the Foreign Exchange Market and Net Exports6.6Real Interest Rates and International Capital Flows6.7The Effect of Trade Policies6.8Fiscal and Monetary Policies in Open Economies6.9Exchange Rate Regimes
← Previous6.5 Changes in the Foreign Exchange Market and Net ExportsNext →6.7 The Effect of Trade Policies
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