19.1: Supply and Demand for Loanable Funds and for Foreign-Currency Exchange

The Market for Loanable Funds:

• At the equilibrium interest rate, the amount that people want to save exactly balances the desired quantities of domestic investment and net capital outflow.

The Market for Foreign-Currency Exchange:

• At the equilibrium real exchange rate, the demand for dollars by foreigners arising from the U.S. net exports of goods and services exactly balances the supply of dollars from Americans arising from U.S. net capital outflow.

• The net capital outflow does not depend on the exchange rate

• Changes in the exchange rate influence both the cost of buying foreign assets and the benefit of owning them, and these two effects offset each other

19.2: Equilibrium in the Open Economy

Net Capital Outflow: The Link between the Two Markets:

• Net-capital-outflow curve is the link between the market for loanable funds and the market for foreign currency exchange.

19.3: How Policies and Events Affect an Open Economy

Government Budget Deficits:

• Government budget deficit represents a negative public saving

  • Reduces national saving (the sum of public and private savings)

  • Reduces the supply of loanable funds

  • Drives up interest rates

  • Crowds out investment

Trade Policy:

• Trade policy- a government policy that directly influences the number of goods and services that a country imports or exports

  • Tariff- a tax on imported goods

  • Import quota- a limit on the quantity of a good produced abroad that can be sold domestically

Political Instability and Capital Flight:

• Capital flight- a large and sudden reduction in the demand for assets located in a country