Initially, real interest rates in the United States, England, and Japan are all equal, at 5 percent. Then the
central banks alter their policies, so that the American interest rate rises to 6 percent, the Japanese rate falls to 4 percent, and the British rate stays at 5 percent.
a) How would you predict that capital flows among the three countries would change?
b) Using supply and demand curves, show how the exchange rates are likely to change.
c) How do you expect the balance of trade in the three countries to change?
d) What quantitative relationship would you expect between the change in the capital flow and the change in the trade balance in each country?
Leftward Shift .
INCREASE IN EXCHANGE
* * decreases.
DECREASE IN EXCHANGE
DI OP 2
* x Quantity