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lecture 23 ~ chapter 13.docx
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Department
Economics
Course
ECON 1BB3
Professor
Hannah Holmes
Semester
Fall

Description
What is a small open economy? Interest rates in a small open economy  Open economy: allows goods, services and capital to flow across borders freely  Small open economy (soe): not large enough to affect world interest rates or world prices  Perfect capital mobility: full access to world financial market (Assuming); no restrictions on ownership of assets across borders Ex. Canada (most are small open economies; 4ish large open economies, china/us/japan (something happens domestically in these countries will hve an impact on Canada but not the other way around); North Korea  closed)  Interest rate parity: in theory, the real interest rate (in Canada) should equal real interest in world financial markets (if we have capitals flowing freely)  real interest rate in Canada = world interest rate o World wide market for loanable funds in every county goes to it in order to borrow for their investment projects, savings is supplies in this  for the world as a whole - what happends to the world market for loanable funds if there is a change in Canada regarding either savings or investment  not a big enough change to affect world interest rates or prices  ninja loan: no income no job or assets but still gets a loan (ex. to buy a house)  interest rate parity is not always perfect for two reasons: 1. risk  2. tax treatment Model of a small open economy Market for loanable funds  S – I = NCO (open)  if domestic saving is bigger than domestic investment, that means that Canadian households and governements are saving more than candians firms want to borrow  can look to borrow in foreign countries; foreign resident is buying a domestic product  if investment is bigger than saving  net capital flow is negative (when world interest rate is
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