Lecture Notes: International Capital Flow

Introduction

• Lecturer: Mr. Willis
• Topic: International Capital Flow
• Definition: Stream of financial capital in monetary funds traveling freely between nations in the open global economy.
• Investment Focus: Financial investments in capital accounts, including assets like stocks, bonds, and interest-bearing accounts.

Capital Flow in Open Economies

• Domestic and Foreign Investments:
  • Domestic investors free to invest in foreign assets.
  • Foreign investors can invest in domestic assets.
  • Represents financial capital flow between open economies.

Impact of Capital Flow

Inbound Capital Flow

• Definition: Occurs when foreign investors purchase domestic assets, injecting funds into the domestic economy.
• Positive Effects:
  • Moves capital account towards a surplus.
  • Increases volume of loanable funds and money supply.
  • Stimulates investment spending by firms leading to real GDP growth.
  • Appreciates domestic currency in the forex market.
• Negative Effects:
  • Causes demand-pull inflation.
  • Appreciation of currency leads to a current account deficit due to increased imports.

Case Study: Japan

• Scenario: Foreign investors purchase Japanese assets using yen, increasing demand in the forex market.
• Effects:
  • Yen appreciates, leading to increased supply of loanable funds.
  • Decrease in real and nominal interest rates.
  • Stimulates investment by domestic firms, increasing aggregate demand and real GDP.
  • Results in demand-pull inflation and a move towards a current account deficit.

Outbound Capital Flow

• Definition: Occurs when domestic investors purchase foreign assets, draining funds from the domestic economy.
• Positive Effects:
  • Can cause deflation.
  • Moves current account towards a surplus as imports decrease.
• Negative Effects:
  • Moves capital account towards a deficit.
  • Decreases loanable funds and money supply, reducing investment spending.
  • Leads to real GDP contraction and currency depreciation.

Case Study: United States

• Scenario: American investors purchase Japanese assets, converting dollars to yen.
• Effects:
  • Dollar depreciates, reducing loanable funds.
  • Increase in real and nominal interest rates.
  • Reduces investment by domestic firms, decreasing aggregate demand and real GDP.
  • Causes deflation, making exports cheaper and imports more expensive.

Conclusion

• Inbound and outbound capital flows have significant impacts on an economy’s capital account, exchange rates, GDP, and inflation.
• Real-world examples illustrate these effects in Japan and the United States.

Additional Resources

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• Further Learning:
  • Macro Minute videos on secrets and long-run effects of capital flow available.