hey everyone I'm mr. Willis and you will love economics international capital flow is defined as the stream of financial capital in Monetary Fund's that travels freely between nations in the open global economy these funds are invested in interest rate accounts and other assets that are connected to the financial investments component of a capital account remember that financial investment refers to the purchase of foreign and domestic financial assets assets can include stocks bonds or any other interest Varian accounts when countries openly trade domestic investors who are looking to earn money on their investments are free to invest in foreign assets just like foreign investors are free to invest in domestic assets the purchase of these assets represents the flow of financial capital between open economies let's take a closer look at the impact of capital flow in the open global economy a country experiences inbound capital flow when foreign investors purchase domestic assets injecting monetary funds into the domestic economy when a country can offer higher real interest rates than any other nations it will experience an inflow of capital as international investors rush to deposit their money into its assets to earn higher yields for example if the United States and Japan are trade partners and Japan's real interest rate is 7% while the real interest rate in the United States is only 5% American investors will liquefy their American assets and to post their money into Japanese assets in order to earn greater profits as a result Japan looks for its inbound capital flow because their financial assets are more profitable so how does inbound capital flow impact an aggregate economy first inbound capital flow will cause a country's capital account to move towards a surplus capital flow is connected to financial investments in the capital account so capital inflow counts as a positive in a nation's capital account balance inbound capital flow also increases the volume of loanable funds available and the supply of money in the domestic economy which will stimulate investment spending by firms and lead to real GDP growth it also increases the value of domestic currency in the foreign exchange market however inbound capital flow will also cause demand pull inflation combined with an increase in consumption and the appreciation of the country's currency in the forex market this will also drive a country's current account balance towards a deficit as domestic consumers purchase more imported goods and services let's walk through the effects of inbound capital flow one graph at a time let's say Japan is experiencing inbound capital flow as foreign investors purchase Japanese assets those assets must be bought in domestic currency which will cause changes in the forex market for the Japanese yen as international investors purchase Japanese assets in greater quantities they're required to convert their currency in the yen in the foreign exchange market this will increase the demand for yen in the foreign exchange market causing the exchange rate for the yen to increase and causing the yen to appreciate in value once foreign investors deposit their yen in the Japanese interest bearing assets Japanese banks will take a portion of each deposit and hold it in required reserves making the excess reserves available for lending in the form of loanable funds this increases the supply of loanable funds available in the Japanese loanable funds market and drives down Japanese real interest rates with more reserves available in the Japanese banking system the supply of m1 m2 and m3 money increases in the Japanese money mark which drives down nominal interest rates in the Japanese economy as nominal interest rates fall Japanese firms will have an incentive to take advantage of cheaper loans firms that are either unwilling or unable to take out loans now have an incentive to take advantage of a lower interest rate to borrow from banks as a result investment spending by domestic firms will increase as investment spending by firms increases the Japanese economy will experience an increase in aggregate demand which signals the firm's across the economy that they need to increase the quantity of products they supply to meet higher demand this will lead to an increase in real GDP output which decreases the unemployment rate increases income and consumption levels and improves Japan's standard of living however look at domestic prices the inbound capital flow coming into Japan may have stimulated spending and growth but it also caused demand pull inflation this means that Japanese exports are now more expensive in the open global economy and as the yen appreciates in the foreign exchange market imported foreign goods coming into Japan are cheaper for Japanese consumers this will cause net exports to decrease in Japan which will move the Japanese current account towards a deficit while the capital account moves towards a surplus a country experiences outbound capital flow when domestic investors purchase foreign assets which drains monetary funds from the domestic economy when a country offers lower real interest rates than other nations it'll experience an outflow of capital as the Messick investors rushed to deposit their money into the assets of foreign nations in order to earn higher yields in our previous example the United States real interest rate was 5% while the realist rate in Japan was 7% as American investors liquefied the domestic assets they drained American banks of reserves and then sent those funds overseas as a result the United States experienced outbound capital flow because their financial assets are less profitable so how does outbound capital flow impact an aggregate economy first outbound capital flow will cause a country's capital account to move towards the deficit capital flow is connected to financial investments in the capital account and so capital outflow counts as a negative in a nation's capital account balance outbound capital flow also decreases the volume of loanable funds available and the supply of money in the domestic economy which will reduce investment spending by firms and lead to real GDP contraction it also decreases the value of domestic currency in the foreign exchange market however outbound capital flow will also cause deflation combined with the decrease in consumption and the depreciation of the country's currency in the forex market this will all to drive a country's current account balance towards a surplus as domestic consumers purchase fewer imported goods and services let's walk through the effects of outbound capital flow one graph at a time let's say the United States is experiencing outbound capital flow as American investors purchase Japanese assets in greater quantities they're required to convert their dollars into yen in the foreign exchange market this will decrease the demand for the dollar in the foreign exchange market causing the exchange rate for the dollar to decrease and causing the dollar to depreciate in value in order to access their money American investors will liquefy their assets and domestic banks as American banks call it loans and use reserves on hand to cover withdrawals the volume of reserves available for lending decreases in the banking system this decreases the supply of loanable funds available in the American loanable funds market and drives up American real interest rates with less reserves available in the American banking system the supply of m1 m2 and m3 money decreases in the American money market which drives up nominal interest rates in the United States economy as nominal interest rates rise American firms will want to avoid paying higher interest on every dollar they borrow domestic firms are now less will in unable to borrow money because it is more expensive now that interest rates are higher as a result investment spending by domestic firms will decrease as investment spending by firms decreases the American economy will experience a decrease in aggregate demand which signals the firm's across the economy that they need to decrease the quantity of products they supply to adjust for lower demand this will lead to a decrease in real GDP output which increases the unemployment rate decreases income and consumption levels and reduces the United States standard of living however look at domestic prices the outbound capital flow from the United States may have reduced spending and led to contraction but it also caused deflation this means that American exports are now less expensive in the open global economy and as the dollar depreciates in the foreign exchange market imported foreign goods coming into the United States are now more expensive for American consumers this will cause net exports to increase in the United States which will move the American count towards a surplus while the capital account moves towards a deficit and that's international capital flow be sure to subscribe to the channel by hitting the red button below so you can receive alerts about new videos when they become available if you enjoy the channel or find my videos useful let me know by liking the video and feel free to leave a comment below we have full video lectures on every topic in macro and micro economics as well as quick macro and micro minute videos for cram sessions and quick reviews if you'd like to learn more you can click here for my macro minute video on secrets of capital flow or you can click here from my macro minute video on long-run effects of capital flow thank you so much for watching I'll see you next time on you'll love economics [Music] you