People widely believe that there is a correlation

19. “People widely believe that there is a correlation between higher interest rates and capital inflows, but this belief is as false as the once accepted belief that there is a correlation between unemployment and inflation, causing the one to go up when the other goes down. These correlations don’t stand up to scientific research.” The correlation between interest rates and capital flows does not stand up because capital inflows are only affected by a higher interest rate ifthere is a current account deficitthere is a balance of payments deficitit is a higher real interest rateit is a higher real interest rate relative to foreign real interest rates20. “U.S. money supply in the October-to-March period grew at a 10 percent annual rate, compared with growth of less than 1 percent between June and October last year. This behavior tends to weaken the U.S. dollar.” This weakens the U.S. dollar becausea) the Fed is not buying as many dollars on the foreign exchange marketb) this restrictive monetary policy is creating a balance of payments deficitc) foreigners anticipate higher U.S. inflation, expect U.S. bond prices to fall and so capital inflows falld) foreigners anticipate lower U.S. inflation, expect U.S. bond prices to rise and so demand for dollars decreases because they buy bonds instead 13521. “Analysts are wondering if Canadian yields can fall while U.S. yields are rising.” This isa) impossible if the risk premium is constantb) possible if Canadian inflation falls while U.S. inflation risesc) possible if Canadian money growth exceeds U.S. money growthd) impossible because real interest rates are approximately equal everywhere

 

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