How would a fall in U.S. interest rates affect Canadian investment, saving, net foreign investment, and the Canadian real exchange rate
A fall in U.S. interest rates can have several effects on Canadian investment, saving, net foreign investment, and the Canadian real exchange rate. Here's an explanation of each:
1. Canadian Investment: A fall in U.S. interest rates may lead to a decrease in borrowing costs for Canadian investors, especially if they are looking to finance their investments with U.S. dollars. This lower cost of borrowing can potentially encourage more Canadian investment in the U.S. As a result, Canadian investment in the U.S. might increase.
2. Canadian Saving: Since interest rates generally influence saving behavior, a fall in U.S. interest rates can impact Canadian saving. Lower interest rates in the U.S. could make saving less attractive for Canadians as returns on savings deposits and bonds may decrease. Consequently, some Canadians may choose to reduce their saving, which could potentially lead to lower levels of domestic saving.
3. Net Foreign Investment: A decrease in U.S. interest rates might spark an increase in Canadian investment in the U.S., as mentioned earlier. This surge in Canadian investment abroad could result in a higher level of net foreign investment. Net foreign investment is the difference between what foreign investors invest in Canada and what Canadians invest abroad. If Canadian investment in the U.S. surpasses foreign investment in Canada, then net foreign investment could rise.
4. Canadian Real Exchange Rate: The real exchange rate is the relative price of domestic goods and services to foreign goods and services, adjusted for inflation. Changes in interest rates can influence exchange rates, which subsequently affect the real exchange rate. When U.S. interest rates fall, it may lead to a decrease in the value of the U.S. dollar compared to the Canadian dollar. A depreciation of the U.S. dollar against the Canadian dollar would cause the Canadian real exchange rate to appreciate, making Canadian goods relatively more expensive compared to foreign goods. This can impact exports and imports, potentially leading to changes in the trade balance.
To assess the exact magnitude and direction of these effects, it's important to consider other factors and variables such as domestic economic conditions, other global macroeconomic factors, and market expectations. Analyzing these factors could provide a more comprehensive understanding of how a fall in U.S. interest rates would impact the specific variables mentioned.