Principles of Economics- Mankiw (5th) 672

Principles of Economics- Mankiw (5th) 672 - 694 PA R T E L...

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694 PART ELEVEN THE MACROECONOMICS OF OPEN ECONOMIES any interest rate, the net-foreign-investment curve also shifts to the right from NFI 1 to NFI 2 , as in panel (b). To see the effects of capital flight on the economy, we compare the old and new equilibria. Panel (a) of Figure 30-7 shows that the increased demand for loanable funds causes the interest rate in Mexico to rise from r 1 to r 2 . Panel (b) shows that Mexican net foreign investment increases. (Although the rise in the interest rate does make Mexican assets more attractive, this development only partly offsets the impact of capital flight on net foreign investment.) Panel (c) shows that the increase in net foreign investment raises the supply of pesos in the market for foreign-currency exchange from S 1 to S 2 . That is, as people try to get out of Mexi- can assets, there is a large supply of pesos to be converted into dollars. This in- crease in supply causes the peso to depreciate from E 1 to E 2 . Thus, capital flight from
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