Chapter 13 Flashcards
What is the market for loanable funds equation?
S = I + NCO Saving = Domestic investment + Net capital outflow
Saving = ?
Supply of loanable funds
What can a dollar of saving be used to finance? (2)
- The purchase of domestic capital
2. The purchase of foreign asset
Demand for loanable funds =
I + NCO
Domestic investment + Net capital outflow
Savings (S) depends ______ on the ________
Positively
real interest rate (r)
Domestic investment (I) depends positively / negatively on r.
Negatively
What is the real interest rate (r) ?
The real return on domestic assets
A fall in r makes domestic/ foreign assets more / less attractive relative to domestic/ foreign assets.
Domestic
Less
Foreign
*This causes net capital outflow (NCO) to rise
The supply and demand for loanable funds depend on what?
The real interest rate (r)
A higher real interest rate encourages people to ____ and _____ the quantity of loanable funds supplied
Save
Raises
The ________ adjusts to bring the supply and demand for loanable funds into balance
Interest rate
At the equilibrium interest rate, the amount that people want to save exactly balances the desired quantities of domestic investment and net foreign investment.
True
Both I and NCO depend ______ on r, so the D curve is ______ ________
Negatively
Downward-sloping
__________ adjusts to balance the supply and demand in the Loanable Funds Market diagram
The real interest rate, r
A budget deficit ______ saving and the demand/ supply of LF, causing _______ to rise
Reduces
Supply
Real interest rate (r)
In a small open economy with perfect capital mobility, like Canada, the domestic interest rate will equal the world interest rate.
True
The quantity of loanable funds made available by the savings of Canadians HAS to equal the quantity of loanable funds demanded for domestic investment.
False
does not have
What is the difference (-) between the quantity of loanable funds made available by the savings of Canadians, and the quantity of loanable funds demanded for domestic investment ?
The net capital outflow (NCO)
Why does the market for foreign-currency exchange exists?
Cause people want to trade with people in other countries, but they want to be paid in their own currency
What does Net Capital Outflow (NCO) represent?
The imbalance between the purchases and sales of capital assets
What does Net Exports (NX) represent?
The imbalance between exports and imports of goods and services
What are the two sides of the foreign-currency exchange market?
Represented by NCO and NX
Net capital outflow = Net Exports.
True
NCO = NX
Which one is represented by supply, and which one is represented by demand? (NX and NCO)
NX = demand for dollars - need $ to buy NX NCO = supply of dollars - residents sell $ to obtain the foreign currency they need to buy foreign assets
S - I = NX
True
What price balances the supply and demand in the market for foreign-currency exchange?
The real exchange rate (E)
What is the Canadian real exchange rate (E)?
It measures the quantity of foreign goods & services, that trade for one unit of Canadian goods & services
Define the real exchange rate (E)
The real value of a dollar in the market for foreign-currency exchange
The demand curve for foreign currency is _______ sloping. Why?
Downward sloping
Because a higher exchange rate makes domestic goods more expensive
The supply curve for foreign currency is ______. Why?
Vertical
Because the quantity of dollars supplied for net capital outflow is unrelated to the real exchange rate.
An ______ in E makes Canadian goods more/ less expensive to foreigners, _______ foreign ______ for Canadian goods – and dollars.
Increase
More
Reduces
Demand
An increase in E has no effect on
_______ or _______, so it does not affect
_______ or the demand/ supply of dollars.
Saving or investement
Net capital outflow (NCO)
Supply
In the graph “the market for foreign-currency exchange” What represent the supply curve? Demand curve?
Supply = Net Capital Outflow Demand = Net Exports
At the equilibrium real exchange rate, the
demand for dollars to buy net exports exactly balances what? to be exchanged into what?
The supply of dollars to be exchanged into foreign currency to buy assets abroad
Disentangling Supply and Demand: When a Canadian resident buys imported goods, does the transaction affect supply or demand in the foreign exchange market?
Affects both, but it’s more convenient to use #2
- The supply of dollars increases
- The demand for dollars decreases
Disentangling Supply and Demand: Why does the supply of dollars increase when a Canadian resident buys imported goods?
Cause the person needs to sell her dollars to obtain the foreign currency she needs to buy the imports
Disentangling Supply and Demand: Why does the demand for dollars decrease when a Canadian resident buys imported goods?
Cause the increase in imports reduces NX, which we think of as the demand for dollars. ( so, NX is really the net demand for dollars)
Disentangling Supply and Demand: When a foreigner buys a Canadian asset, does the transaction affect supply or demand in the foreign exchange market?
Affects both, but it’s more convenient to use #2
- The demand for dollars increases
- The supply of dollars falls
Disentangling Supply and Demand: Why does the demand for dollars increase when a foreigner buys a Canadian asset?
Cause the foreigner needs dollars in order to purchase the Canadian asset
Disentangling Supply and Demand: Why does the supply of dollars fall when a foreigner buys a Canadian asset?
Cause the transaction reduces NCO, which we think of as the supply of dollars.
(So, NCO is really the net supply of dollars)
In the market for foreign-currency exchange, what does NX equal when the government budget is balanced, and trade is balanced?
NX=0
In the foreign-currency exchange graph, what happens to NX, r and NCO when the government runs a budget deficit?
r rises
NCO falls
Reduces net exports
(NX=0 initially, therefore with deficit NX<0)
The five effects of a budget deficit?
- Nation saving falls
- The real interest rate rises
- Domestic investment and net capital outflow both fall
- The real exchange rate appreciates
- Net exports fall(or trade deficit increases)
Net capital outflow is the variable that links which two markets?
S= I + NCO (market for loanable funds) NCO = NX (market for foreign-currency exchange)
In the market for loanable funds, supply comes from _________ and demand comes from ___________ and __________
National saving
Domestic investment and net capital outflow
In the market for foreign-currency exchange, ______ comes from net capital outflow and _____ comes from net exports
Supply
Demand
In the market for loanable funds (graph), what is net capital outflow? Equation?
The space, above equilibrium, between the supply and demand curve
NCO (S-I)
In the market for foreign-currency exchange (graph), what is the supply and demand for dollars represented by?
Supply = S-I Demand = NX
Prices in the loanable funds market and the
foreign-currency exchange market adjust
simultaneously to balance supply and demand in these two markets.
True
In the equilibrium of an open economy, the supply and demand curves balance to determine which macroeconomics variables ? (4)
Of national saving, domestic investment, net foreign investment, and net exports
In an open economy, the magnitude and variation in important macroeconomic variables depend on the following: (4)
- Increase in the world interest rate
- Govt budget deficits and surpluses
- Trade policies
- Political and economic stability
What are the steps to analyzing the events in an open economy?
- Determine which of the supply and demand curves each event affects
- Determine which way the curves shift
- Examine how these shifts alter the economy equilibrium
Events outside Canada, that cause the world interest rates to change, do not have an important effect on the Canadian economy.
False, they CAN have important effect on the Canadian economy
In a small open economy with perfect mobility, an increase in the world interest rate crowds out ______ investment, causes the dollar to ______, and causes net exports to ____.
Domestic
Depreciate
Rise
In the market for loanable funds, what happens to NCO when there’s an increase in the world interest rate?
Causes NCO to increase
In the market for foreign-currency exchange, the increase in net capital outflow increases/ decreases the demand/supply of dollars to be exchanged into foreign currency.
Increases
Supply
An increase in NCO, increases the supply of dollars to be exchanges into foreign currency, which cause the real exchange rate to?
Depreciate
Because a government budget deficit represents positive/ negative public saving, it reduces _________, and therefore reduces. . .(3)
Negative National Saving 1. The supply of loanable funds 2. Net capital outflow 3. The supply of Canadian dollars in the market for foreign-currency exchange
In the graph for loanable funds (increase in govt deficit).. An increase in the government budget deficit reduces national saving, which reduces __________.
Net capital outflow
Shifts the supply curve to the left
Define a trade policy
A government policy that directly influences the quantity of goods and services that a country imports or exports
Define tariff
A tax on an imported good
Define import quota
A limit on the quantity of a good produced abroad and sold domestically
Trade policy - the effect of an import quota: The initial impact is on _____, which affects _______
Imports
Net exports
Trade policy - the effect of an import quota: Net exports are the source of demand/ supply for dollars in the market for ________, affecting demand/ supply in this market
Demand
foreign-currency exchange
demand
Trade policy - the effect of an import quota: Imports rises/ are reduced at any exchange rate, and net exports will rise/ are reduced
Reduced
Rise
Trade policy - the effect of an import quota: This increases/ decreases the demand for dollars in the market for __________
Increases
Foreign-currency exchange
In the market for loanable funds, how does and import quota affect net capital outflow and net exports?
They remain the same
In the market for foreign-currency exchange, how does an import quota affect the demand for dollars? What happens to the real exchange rate?
Demand increases
real exchange rate appreciates
Trade policy - effect of an import quota: Because foreigners need dollars to buy
Canadian net exports, there is an increased
demand for dollars in the market for foreign-currency.
True
Trade policy - effect of an import quota: There is no change in the market for loanable funds, but there is a change in net capital outflow
False; There is no change in the market for loanable funds, and therefore, no change in net capital outflow
Trade policy - effect of an import quota: Net exports will be reduced, since an import quota reduces imports.
False; There will be no change in net exports even though an import quota reduces imports.
Trade policy - effect of an import quota: An appreciation of the dollar in the foreign
exchange market encourages/ discourages imports and encourages/ discourages exports.
Encourages
Discourages
Trade policies affect the trade balance.
False; they do not affect the trade balance
Define Capital flight
It is a large and sudden reduction in the demand for assets located in a country.
Capital flight: has its largest impact on the country from which the capital is fleeing, but it also affects other countries.
True
If investors become concerned about the safety of their investments, capital can not quickly leave an economy.
False, it can quickly leave the economy
Capital can quickly leave the economy, therefore interest rates increase/ decrease and the domestic currency appreciate/ depreciates
Increase
Depreciates
Capital flight (Mexican - NCO): An increased demand for loanable funds in the loanable funds market leads the interest rate to _______. This _______ the supply of pesos in the foreign-currency exchange market.
Increase
Increased
Market for loanable funds in mexico - Capital flight : An increase in the perceived risk of holding Mexican assets increases/ decreases the interest rate paid on Mexican ______ by the amount of the risk premium
Increases
Assets
Market for loanable funds in mexico - Capital flight : To save the same amount as before, Mexican savers must also receive the __________
Risk premium
Market for loanable funds in mexico - Capital flight : With the quantity of loanable funds supplied unchanged, and the quantity demanded reduced, Mexico’s net capital outflow rises/ decreases
Rises
The market for foreign-currency exchange - Capital flight: The increase in Mexico’s net capital outflow increases/ decreases the supply of pesos, which causes the peso to appreciate/ depreciate
Increases
Depreciate
In which two ways is the Canadian economy becoming increasingly open?
- Trade in goods and services is rising relative to GDP.
2. Increasingly, people hold international assets in their portfolios and firms finance investment with foreign capital
In an open economy, the real interest rate adjusts to balance the __________ (saving) with the ________ (domestic investment
and net capital outflow).
The supply of loanable funds
The demand for loanable funds
In the market for foreign-currency exchange, the real exchange rate adjusts to balance the supply of dollars (______) with the demand for dollars (________).
Net capital outflow
Net exports
__________ is the variable that connects an open economy, and the market for foreign-currency exchange
Net capital outflow
A budget deficit ______ national saving, ______ interest rates, ________ net capital outflow, _________ the supply of dollars in the foreign exchange market, _________ the exchange rate, and _______ net exports.
Reduces Drives up Reduces Reduces Appreciates Reduces
A policy that restricts imports does not affect __________, so it cannot affect ________ or _______ a country’s trade deficit. Instead, it drives up the ________ and reduces ____ as well as ______.
Net capital outflow Net exports Improve Exchange rate Exports Imports
Political instability may cause _________,
as nervous investors sell assets and pull their capital out of the country. As a result, interest rates _____ and the country’s exchange rate ____.
Capital flight
Rise
Falls
