1. Net Capital Outflow NCO = S - Ig

2. The market for loanable funds, net capital outflow and the fx market for dollars NCOD S QUANTITY OF DOLLARS D Negative NCO Real exchang e rate Real interest rate Quantity of loanable funds S Positive NCO

3. A budget deficit will affect the market for loanable funds, net capital outflow and the fx market for dollars NCOD S QUANTITY OF DOLLARS D Negative NCO Real exchang e rate Real interest rate Quantity of loanable funds S Positive NCO

4. The gov’t deficit competes for savings available for loans, this can be seen as fewer private sector savings available for firm investment NCOD S QUANTITY OF DOLLARS D Negative NCO Positive NCO Real exchang e rate Real interest rate Quantity of loanable funds S1 The Market for Dollars S

5. Or, the Gov’t borrowing can be seen as an increase in demand for loans; producing a decrease in quantity supplied to the private sector. NCOD S QUANTITY OF DOLLARS D Negative NCO Real exchang e rate Real interest rate Quantity of loanable funds D1 The Market for Dollars S Positive NCO

6. Only the fx market for dollars is affected by a tariff or quota NCOD S QUANTITY OF DOLLARS D Negative NCO Real exchang e rate Real interest rate Quantity of loanable funds S Positive NCO D1