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ECN 204 (348)

ECN204 Chapter 13.doc

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ECN 204
Christos Shiamptanis

ECN204Chapter 13The Market for Loanable FundsoAn identity from the preceding chapterSINCOoSupply of loanable fundssavingoA dollar of saving can be used to financeThe purchase of domestic capitalThe purchase of a foreign assetSo the demand for loanable fundsINCOoRecallS depends positively on the real interest rate rI depends negatively on rWhat about NCOoThe supply and demand for loanable funds depend on the real interest rateoA higher real interest rate encourages people to save and raises the quantity of loanable funds suppliedoThe interest rate adjusts to bring the supply and demand for loanable funds into balanceoAt the equilibrium interest rate the amount that people want to save exactly balances the desired quantities of domestic investment and net foreign investmentoIn a small open economy with perfect capital mobility like Canada the domestic interest rate will equal the world interest rateoAs a result the quantity of loanable funds made available by the savings of Canadians does not have to equal the quantity of loanable funds demanded for domestic investmentoThe difference between these two amounts is NCOHow NCO Depends on the Real Interest RateoThe real interest rate r is the real return on domestic assetsoA fall in r makes domestic assets less attractive relative to foreign assetsCanadians purchase more foreign assetsCanadians purchase fewer domestic assetsNCO risesThe Market for ForeignCurrency ExchangeoThe market for foreigncurrency exchange exists because people want to trade with people in other countries but they want to be paid in their own currencyThe two sides of the foreigncurrency exchange market are represented by NCO and NXNCO represents the imbalance between the purchases and sales of capital assetsNX represents the imbalance between exports and imports of goods and servicesoAnother identity from the preceding chapterNCONXoIn the market for foreigncurrency exchange
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