Chapter 19 A Macroeconomic Theory of the Open Economy

Chapter 19 A Macroeconomic Theory of the Open Economy -...

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Chapter 19 A Macroeconomic Theory Supply and Demand for Loanable Funds and for Foreign Cur- rency Exchange The Market for Loanable Funds S = I + NCO The real Interest rate in an open economy is determined by the supply and demand of its loanable funds. National saving is the source of supply of the loanable funds. Domestic investment and net capital outflow are the sources of the demand for loanable funds. At the equilibrium interest rate, the amount that people want to save exactly balances the amount that people want to borrow for the purpose of buying domestic capital and foreign assets. When real interest rate increases---> w (inflow goes up, outflow goes down), --->sup- ply of loanable funds goes up, demand goes down The Market for Foreign Currency Exchange NCO = NX The real exchange rate is determined by the supply and demand for foreign currency exchange. The supply of dollars to be exchanged into foreign currency comes from net capital outflow . Be- cause net capital outflow does not depend on the real exchange rate, the supply curve is vertical. The demand for dollars comes from net exports . Because a lower real exchange rate stimulates net exports (and thus increases the quantity of dollars demanded to pay for these net exports), the demand curve is downward sloping. At the equilibrium real exchange rate, the number of dollars people supply to buy foreign assets exactly balances the number of dollars people demand to buy net exports. When real exchange rate increases(
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This note was uploaded on 07/03/2010 for the course ECON 201 taught by Professor Salehie during the Spring '08 term at University of Washington.

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Chapter 19 A Macroeconomic Theory of the Open Economy -...

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