AMacroeconomic Theory of the Open Economy
Market for Loanable Funds
Loanable funds: the domestically generated flow of resources available for capital
S = I + NCO
Supply comes from savings
Demand comes from domestic investment and net capital outflow
Real interest rate balances supply and demand
Ahigher 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.
Ahigh 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.
Market for Foreign Currency Exchange
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.
At the equilibrium real exchange rate, the demand for dollars by foreigners
arising from the U.S net exports of goods and services exactly balances the
supply of dollars fromAmericans arising from U.S. net capital outflow.
Net Capital Outflow: the Link between the Two Markets
Demand in loanable funds, supply in foreign-currency excha