Scenario 33-1

Question

Suppose that political instability in other countries makes people fear for the value of their assets in these countries so that they desire to purchase more U.S assets.

Refer to Scenario 33-1. What would the change in the interest rate created by foreigners wanting to buy more U.S. assets do to investment spending in the United States?
a. Make it rise which by itself would decrease U.S. aggregate demand.
b. Make it fall which by itself would decrease U.S. aggregate demand.
c. Make it rise which by itself would increase U.S. aggregate demand.
d. Make it fall which by itself would increase U.S. aggregate demand.

Answer 1

When foreigners decide to purchase more U.S. assets due to political instability in their own countries, this increase in demand for U.S. assets typically leads to an increase in the flow of foreign capital into the United States. This can lead to a few outcomes:

1. Increase in Capital Inflows: As foreigners buy more U.S. assets (like treasury bonds, stocks, etc.), the demand for U.S. dollars increases, which can lead to an appreciation of the dollar.

2. Interest Rates: With an increase in demand for U.S. assets, the supply of money may become more abundant, leading to a decrease in interest rates. Lower interest rates generally encourage more borrowing and spending, which can increase investment spending by businesses.

Given these dynamics, here's how it specifically interacts with investment spending:

• Lower interest rates make borrowing cheaper for firms, which will likely encourage them to increase their investment spending.

In terms of the options provided: a decrease in interest rates would typically lead to an increase in investment spending. This increased investment spending contributes to an increase in aggregate demand.

Therefore, the correct response would be:

d. Make it fall which by itself would increase U.S. aggregate demand.