ECON 201 Chapter Notes -Exchange Rate, Loanable Funds, Real Interest Rate
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11 Mar 2014
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Loanable funds: the domestically generated flow of resources available for capital accumulation. Demand comes from domestic investment and net capital outflow. Real interest rate balances supply and demand. A higher real interest rate encourages people to save and raises the quantity of loanable funds supplied. Also, makes borrowing to finance capital projects more costly, discouraging it and reducing the quantity demanded. A high u. s. real interest rate, discourages from buying foreign assets and buy u. s ones, reducing net capital outflow. At the equilibrium interest rate, the amount that people want to save exactly balances the desired quantities of domestic investment and net capital outflow. Real exchange rate balances supply and demand. Appreciation of the real exchange rate reduces the quantity of dollars demanded in the market for foreign-currency exchange. Net capital outflow does not depend on exchange rates (supply curve) because foreign assets will be cheaper but also the money will be lost when converted back into u. s. dollars.
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