Question

If a country is a net borrower on the global foreign exchange market, explain how the domestic real interest rate compares to the world real interest rate.

Answer 1

If a country is a net borrower, it means the balance of payment will have a debit balance and the loans to the world are a big liability. This borrwoing would mean burden of interest payment and principal payment. As money borrowed is invested into the country, the money supply increases which leads to inflation to stop which government will try to reduce money supply and also maintain foreign exchange parity by increasing interest rates to discourage people from taking loans and also to increase interest income so as to pay for the debts taken themselves. Domestic interest rate would be greater than world real interest rate