In open-economy macroeconomics, the real interest rate determined in the loanable funds market governs net capital outflow: a higher domestic real interest rate raises the relative return on domestic financial assets, attracting foreign lending and reducing net capital outflow, while a lower real interest rate drives residents to acquire foreign assets and increases net capital outflow. Net capital outflow in turn determines the quantity of domestic currency supplied to the foreign exchange market, so a fall in outflow contracts the currency supply and causes appreciation, whereas a rise in outflow expands it and causes depreciation. This mechanism is the linkage that unifies the loanable funds market, the balance-of-payments financial account, and the foreign exchange market within introductory macroeconomic theory, complementing the aggregate-demand/aggregate-supply, business cycle, production possibilities, Phillips curve, and money market models that each locate the economy in a recessionary gap, full employment, or an inflationary gap.
In open-economy macroeconomics, the real interest rate determined in the loanable funds market governs net capital outflow: a higher domestic real interest rate raises the relative return on domestic…