UNTIL FAIRLY RECENTLY, THE STANDARD THEORY concerning international
financial capital flows-movements of nondirect investment items
in the capital account-related capitalfiows to levels of interest differentials.
According to this "flow theory," an increase in foreign short-term interest
rates would increase the outflow of capital from the United States, and as
long as foreign interest rates remained higher than American rates, the
flow would continue. Conversely, one way for the United States to improve
its balance on capital account would be to raise its rates, and as long as
U.S. rates remained higher than foreign rates, the capital account would
show a reduced deficit.