Question

In a small open economy with perfect capital mobility, if the domestic interest rate were to rise above the world interest rate, then ______ would drive the domestic interest rate back to the level of the world interest rate.

Answer 1

... capital inflow would drive the domestic interest rate back to the level of the world interest rate

Step-by-step explanation:

When domestic interest rate becomes higher than world level, investing money in the country becomes attractive. With perfect capital mobility, international investors would be able to easily bring their capital (money) in to earn higher returns. Abundant capital would drive down interest rate back to world level.