A Macroeconomic Theory of the Open Economy 32 A Macroeconomic Theory of the Open Economy
Figure 1 The Market for Loanable Funds Real interest rate Supply of loanable funds (from national saving) Demand for loanable funds (for domestic investment and net capital outflow) Equilibrium quantity real interest rate Quantity of loanable funds Copyright © 2011 Cengage Learning
Figure 2 The Market for Foreign Currency Exchange Real exchange rate Supply of pounds (from net capital outflow) Demand for pounds (for net exports) Equilibrium quantity real exchange rate Quantity of pounds exchanged into foreign currency Copyright © 2011 Cengage Learning
Figure 3 How Net Capital Outflow Depends on the Interest Rate Real interest rate Net capital outflow is negative. Net capital outflow is positive. Net capital outflow Copyright © 2011 Cengage Learning
Figure 4 The Real Equilibrium in an Open Economy (a) The market for loanable funds (b) Net capital outflow Real Real interest interest Net capital outflow, NCO Supply rate rate Demand r Quantity of Net capital loanable funds outflow Real exchange Supply rate Demand E Quantity of pounds (c) The market for foreign currency exchange Copyright © 2011 Cengage Learning
Figure 5 The Effects of a Government Budget Deficit 1. A budget deficit reduces the supply of loanable funds . . . (a) The market for loanable funds (b) Net capital outflow Real Real interest S S Interest rate Rate r2 B r2 E1 r A 2. . . . which increases the real interest rate . . . 3. . . . which in turn reduces net capital outflow. Demand NCO Quantity of Net capital loanable funds outflow Real exchange S S rate 4. The decrease in net capital outflow reduces the supply of pounds to be exchanged into foreign currency . . . E2 5. . . . which causes the real exchange rate to appreciate. Demand Quantity of pounds (c) The market for foreign currency exchange Copyright © 2011 Cengage Learning
Figure 6 The Effects of an Import Quota (a) The market for loanable funds (b) Net capital outflow Real Real interest Supply interest rate rate r r 3. Net exports, however, remain the same. Demand NCO Quantity of Net capital loanable funds outflow Real exchange Supply rate D 1. An import quota increases the demand for pounds . . . E2 2. . . . and causes the real exchange rate to appreciate. E D Quantity of pounds (c) The market for foreign-currency exchange Copyright © 2011 Cengage Learning
Figure 7 The Effects of Capital Flight (a) The market for loanable funds in Mexico (b) Mexican net capital outflow Real Real 1. An increase in net capital outflow. . . Interest Supply Interest NCO2 Rate D2 Rate r2 3. . . . which increases the interest rate. r1 r1 2. . . . increases the demand for loanable funds . . . D1 NCO1 Quantity of Net capital loanable funds outflow Real exchange S S2 rate 4. At the same time, the increase in net capital outflow increases the supply of pesos . . . E 5. . . . which causes the peso to depreciate. E Demand Quantity of pesos (c) The Market for Foreign-Currency Exchange Copyright © 2011 Cengage Learning