In a small open economy with imperfect capital mobility, MPS = 0.25, MPM = 0.15, and interest sensitivity of capital flows φ = 0.4. A foreign country raises its interest rate by 2 percentage points. If the domestic economy maintains its interest rate unchanged, the resulting BOP position and required policy response are:

BP curve slope = (MPM + MPS)/φ = (0.15 + 0.25)/0.4 = 1.0 (positively sloped — imperfect capital mobility). When r* rises by 2% and domestic r is unchanged: foreign assets become relatively more attractive → capital outflows → capital account worsens → BOP deficit. The domestic r must rise by exactly Δr* = 2% at every income level to restore BOP equilibrium. Graphically, the BP curve shifts vertically upward by 2%.   Why others are wrong:
• (A) — Higher foreign r* causes OUTFLOWS, not inflows.   • (B) — The formula (MPM+MPS)/φ is the BP slope, NOT the required interest rate rise. The required rise is simply Δr* = 2%   • (D) — Imperfect mobility ≠ zero mobility. Only a vertical BP (perfect immobility) would insulate the economy.