Week nine learning Flashcards
What are the important macroeconomic variables of an open economy?
Net exports, net foreign investment, nominal exchange rates, and real exchange rates.
What two markets are central in the model of an open economy?
The market for loanable funds and the market for foreign-currency exchange.
In the market for loanable funds, what is the supply and demand relationship?
Supply comes from national saving (S), and demand comes from domestic investment (I) and net foreign investment (NFI). The relationship is given by S = I + NFI
How does the interest rate affect the market for loanable funds?
The interest rate adjusts to balance the supply of and demand for loanable funds. At equilibrium, saving exactly balances domestic investment and net foreign investment.
What do NFI and CAB represent in the foreign-currency exchange market?
NFI represents the imbalance between purchases and sales of capital assets, while CAB represents the imbalance between exports and imports of goods and services, plus net income and transfers.
How do NFI and CAB relate in the foreign-currency exchange market?
For an economy as a whole, NFI must equal CAB. The real exchange rate balances the supply and demand for foreign currency.
What is the real exchange rate and how does it adjust in the FX market?
The real exchange rate adjusts to balance the quantity demanded of dollars for net exports with the quantity supplied of dollars for net foreign investment.
How does the real interest rate determine the equilibrium in the loanable funds and FX markets?
The real interest rate adjusts in both markets to balance supply and demand. It influences national saving, domestic investment, net foreign investment, and the current account balance.
What are some factors that can influence macroeconomic variables in an open economy?
Changes in consumer and business confidence, government budget deficits, trade policies, and political and economic stability.
What are the effects of a government budget deficit on the loanable funds market?
A government budget deficit reduces the supply of loanable funds, increases the interest rate, reduces net foreign investment (NFI), and leads to an appreciation of the domestic currency, which can decrease net exports.
What are trade policies and how do they impact net exports?
Trade policies such as tariffs and import quotas directly influence the quantity of goods and services imported or exported. However, in this model, they do not impact national saving, domestic investment, or the trade balance.
What is capital flight and its effects on an economy?
Capital flight is a large and sudden reduction in the demand for assets located in a country, often due to instability. It leads to increased interest rates and depreciation of the domestic currency
What is the summary of the equilibrium in an open economy?
The interest rate in the loanable funds market adjusts to balance saving with domestic investment and net foreign investment. The real exchange rate in the FX market adjusts to balance the supply and demand for dollars, connecting NFI and CAB.
