Principles of Economics- Mankiw (5th) 671

Principles of Economics- Mankiw (5th) 671 - Figure 30-7 T...

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CHAPTER 30 A MACROECONOMIC THEORY OF THE OPEN ECONOMY 693 Now consider which way these curves shift. When net foreign investment in- creases, there is greater demand for loanable funds to finance these purchases. Thus, as panel (a) of Figure 30-7 shows, the demand curve for loanable funds shifts to the right from D 1 to D 2 . In addition, because net foreign investment is higher for (a) The Market for Loanable Funds in Mexico (b) Mexican Net Foreign Investment Real Interest Rate Real Interest Rate (c) The Market for Foreign-Currency Exchange Quantity of Pesos Quantity of Loanable Funds Net Foreign Investment Real Exchange Rate r 1 1 D 1 2 E 2 1 Demand 2 2 S 1 2 Supply NFI 2 1 1. An increase in net foreign investment . . . 3. . . . which increases the interest rate. 2. . . . increases the demand for loanable funds . . . 4. At the same time, the increase in net foreign investment increases the supply of pesos . . . 5. . . . which causes the peso to depreciate.
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Unformatted text preview: Figure 30-7 T HE E FFECTS OF C APITAL F LIGHT . If people decide that Mexico is a risky place to keep their savings, they will move their capital to safer havens such as the United States, resulting in an increase in Mexican net foreign investment. Consequently, the demand for loanable funds in Mexico rises from D 1 to D 2 , as shown in panel (a), and this drives up the Mexican real interest rate from r 1 to r 2 . Because net foreign investment is higher for any interest rate, that curve also shifts to the right from NFI 1 to NFI 2 in panel (b). At the same time, in the market for foreign-currency exchange, the supply of pesos rises from S 1 to S 2 , as shown in panel (c). This increase in the supply of pesos causes the peso to depreciate from E 1 to E 2 , so the peso becomes less valuable compared to other currencies....
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