ECON 2 Lecture Notes - Lecture 32: Loanable Funds, Real Interest Rate, Government Spending
Supply and Demand for Loanable Funds and for Foreign Currency Markets --> combining chapter 26 with
chapter 31
Savings S = Y - C(r,T,P) - G
Savings are decided in an economy by
1. National income Y
2. National consumption C, a function of the real interest rate r, taxes net transfers T and
government policy P
3. Government spending G
Savers supply loanable funds to home country residents
Difference: investors may invest borrowed home savings abroad or Foreigners may invest borrowed
foreign country savings at home
• If US is home country, US citizens may borrow from US banks to invest abroad. Japanese residents
may borrow from Japanese banks to invest in the US
• KEY: we are only looking at quantity of loanable funds exchanged in home country
• In our model, when NCO is positive, investment is being made abroad using US "savings" S
• When NCO is negative, capital is flowing into the home country using foreign savings
o We can take it as borrowers from abroad are bringing their own savings into the market.
This increases investment at home w/o using savings from home
I(r,P) + NCO(r,vh,Rf,vf)
• r is real interest rate
• V is variability or risk
• R is Return
I decreases in r (i.e. as r goes up I goes down)
NCO decreases in r
• Higher r means its more expensive to invest using home
NCO increase in vh
• Riskier home means capital leaves
NCO increases in Rf
• Higher returns abroad means capital leaves
For graphing purposes…
• Demand = I + NCO
• Supply = S
**NCO does not depend on exchange rate**
• Expected future exchange rate is the same as the current exchange rate
Document Summary
Supply and demand for loanable funds and for foreign currency markets --> combining chapter 26 with chapter 31. Savings s = y - c(r,t,p) - g. Savings are decided in an economy by: national income y, national consumption c, a function of the real interest rate r, taxes net transfers t and government policy p, government spending g. Savers supply loanable funds to home country residents. Difference: investors may invest borrowed home savings abroad or foreigners may invest borrowed foreign country savings at home. If us is home country, us citizens may borrow from us banks to invest abroad. In our model, when nco is positive, investment is being made abroad using us savings s: we can take it as borrowers from abroad are bringing their own savings into the market. This increases investment at home w/o using savings from home. I(r,p) + nco(r,vh,rf,vf) r is real interest rate: v is variability or risk, r is return.
