1. A Macroeconomic Theory of the Open Economy32
A Macroeconomic Theory of the Open Economy

2. 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
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3. 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
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4. 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
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5. 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
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6. 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
which
increases
the real
interest
rate . . .
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
which
causes the
real exchange
rate to
appreciate.
Demand
Quantity of
pounds
(c) The market for foreign currency exchange
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7. 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
and
causes the
real exchange
rate to
appreciate. E D
Quantity of
pounds
(c) The market for foreign-currency exchange
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8. 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
which
increases
the interest
rate. r1 r1
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
which
causes the
peso to
depreciate. E
Demand
Quantity of
pesos
(c) The Market for Foreign-Currency Exchange
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