Textbook Guide Economics: Exchange Rate, Loanable Funds, Real Interest Rate

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Published on 1 Dec 2016
School
UTSG
Department
Economics
Course
ECO102H1
Professor
A Macroeconomic Theory of the Open Economy
Supply and Demand for Loanable Funds and for Foreign-Currency Exchange
S = I + NCO
o S = saving
o I = domestic investment
o NCO = net capital outflow
A high real interest rate in the U.S. discourages investment in foreign
assets by Americans and encourages foreigners to buy U.S. assets.
As the figure above shows, the interest rate in an open economy is
determined by the supply and demand for loanable funds.
NCO = NX
o NCO = net capital outflow
o NX = net exports
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The figure above shows how the real exchange rate is determined by the
supply and demand for foreign-currency exchange.
A higher real exchange rate makes U.S. goods relatively more expensive
and reduces the quantity of dollars demanded to buy those goods.
Equilibrium in the Open Economy
S = I + NCO
NCO = NX
o S = national saving
o I = domestic investment
o NCO = net capital outflow
o NX = net exports
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The figure above shows how net capital outflow depends on the interest
rate.
Since a higher domestic real interest rate makes domestic assets more
attractive, it reduces net capital outflow.
The figure above shows the relationship between the market for loanable
funds, net capital outflow, and the market for foreign-currency exchange.
How policies and Events Affect an Open Market Economy
The figure below shows the effects of a budget deficit in an open economy
step by step.
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Document Summary

Supply and demand for loanable funds and for foreign-currency exchange. S = i + nco: s = saving, i = domestic investment, nco = net capital outflow. A high real interest rate in the u. s. discourages investment in foreign assets by americans and encourages foreigners to buy u. s. assets. As the figure above shows, the interest rate in an open economy is determined by the supply and demand for loanable funds. Nco = nx: nco = net capital outflow, nx = net exports. The figure above shows how the real exchange rate is determined by the supply and demand for foreign-currency exchange. A higher real exchange rate makes u. s. goods relatively more expensive and reduces the quantity of dollars demanded to buy those goods. Nco = nx: s = national saving, i = domestic investment, nco = net capital outflow, nx = net exports. The figure above shows how net capital outflow depends on the interest rate.

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