A

MACROECONOMIC
THE ORY OF OPEN ECONOMY

prepared by L e d i Tr i a l d i
 A
MACROECONOMIC
THE ORY OF OPEN ECONOMY

 The Market For Loanable

Funds in an Open Economy
 The Market for Foreign-
Currency Exchange
 Long-Run Open Economy
 Model
Event or Policy Implication
 OPEN
ECONOMY

real interest rate

𝑆 𝐿𝐹
THE MARKET
FOR
L
O APNP LY
SU A BOLFE F U N D S
L O A NSaving
National A B L Public
E F USaving
N D SPrivate
Saving
Domestic real interest rate incentive for
𝑟 𝐸0 saving
 DEMAND FOR LOANABLE
F UND
Private S
Investment Net Capital Outflow
: demand for loanable funds rises
: demand for loanable funds declines
Domestic real interest rate
𝐷 𝐿𝐹 ost of borrowing for private investment
𝐿 opportunity cost for capital outflow
𝐿 quantity of
loanable
OPEN
 OPEN
ECONOMY

real exchange rate

𝑆𝐶 THE MARKET
FOR
FOREIGN-CURRENCY
 S U P P LY O F D O M E S T I C
EXCHANGE
Cmoney
U R Rsupply
ENCY
net capital outflow (NCO)/funds for buying foreign
𝑅 𝐸𝑅 𝐸 0 (𝑁𝐶𝑂=𝑁𝑋) assets
affected by real interest rate, not by real exchange
rate
cheaper foreign assets less benefit of owning them

 DEMAND FOR DOMESTIC

CnetUexport
RRENCY
appreciation net export declines
𝐷𝐶 depreciation net export rises

𝑄𝐶 quantity of
𝑄
domestic
OPEN
real interest rate real interest rate
𝑆 𝐿𝐹

𝐷 𝐿𝐹
quantity of
𝑁 𝐶𝑂
net capital
𝑄 𝐿𝐹 loanable fund
𝑁 𝐶𝑂 flow
real exchange rate 𝑆𝐶

LONG-
OPEN ECONOMY
R U N MODEL 𝑅𝐸𝑅

𝐷𝐶
quantity of do-
𝑄𝐶 mestic
currency
COMPREHEND
MORE...
real interest rate real interest rate
𝑆 𝐿𝐹
𝑆 𝐿𝐹 ′

𝑟
𝑟′
BUDGET
SURPLUS
𝐷 𝐿𝐹
quantity of
𝑁 𝐶𝑂
net capital Saving
𝑄 𝐿𝐹 ’ loanable fund 𝑁 𝐶𝑂 ’ flow
Private investment
real exchange rate 𝑆𝐶 ’
Net Capital Outflow
Real interest rate
CASE
Real Exchange Rate
1:
BUDGET Net Export

SURPLUS 𝑅𝐸𝑅
’ (↑ 𝑁𝐶𝑂=↑ 𝑁𝑋 )
𝐷𝐶
quantity of do- LONG-
𝑄𝐶 ’ mestic OR
P EU
N N
ECONOMY
real interest rate real interest rate
𝑆 𝐿𝐹

𝑟
E X P O RT
S
H IU
G HB
E RS N
IDE TY
EXPORT
𝐷 𝐿𝐹
quantity of
𝑁 𝐶𝑂
net capital
𝑄 𝐿𝐹 loanable fund
𝑁 𝐶𝑂 flow Real Exchange Rate
real exchange rate 𝑆𝐶 The other variables are
unaffected
(𝑁𝐶𝑂=𝑁𝑋)
CASE
2: 𝑅𝐸𝑅 ′
EXPORT
SUBSIDY 𝑅𝐸𝑅
’
𝐷𝐶
quantity of do- LONG-
𝑄𝐶 mestic OR
P EU
N N
ECONOMY
real interest rate real interest rate
𝑆 𝐿𝐹

𝑟′
𝑟
POLITICAL
𝐷 𝐿𝐹 ′ 𝑁 𝐶𝑂 ′ I( N
C ASPTA BLI LFILTI Y
ITA GHT)
𝐷 𝐿𝐹
quantity of
𝑁 𝐶𝑂
net capital
𝑄 𝐿𝐹 ’ loanable fund 𝑁 𝐶𝑂
𝑁 𝐶𝑂 ′ flow Net Capital Outflow
real exchange rate 𝑆𝐶 ’ Private investment
Real interest rate

CASE Real Exchange Rate

3: Net Export
CAPITAL
FLIGHT 𝑅𝐸𝑅
𝑅𝐸𝑅 ′
𝐷𝐶
quantity of do- LONG-
𝑄𝐶 ’ mestic OR
P EU
N N
ECONOMY
real interest rate real interest rate
𝑆 𝐿𝐹

𝑟′
𝑟
HIGHER
𝐷 𝐿𝐹 ′ 𝑁 𝐶𝑂 ′ IANB T
RE RDE S T R AT E
OA
𝐷 𝐿𝐹
quantity of
𝑁 𝐶𝑂
net capital
𝑄 𝐿𝐹 ’ loanable fund 𝑁 𝐶𝑂
𝑁 𝐶𝑂 ′ flow Net Capital Outflow
real exchange rate 𝑆𝐶 ’ Private investment
Real interest rate

CASE Real Exchange Rate

4: Net Export
HIGHER
INTEREST 𝑅𝐸𝑅
𝑅𝐸𝑅 ′
R AT E
𝐷𝐶
ABROAD quantity of do- LONG-
𝑄𝐶 ’ mestic OR
P EU
N N
ECONOMY
COMPREHEND
MORE...
 A
MACROECONOMIC
THE ORY OF OPEN ECONOMY

 The Market For Loanable

Funds in an Open Economy
 The Market for Foreign-
Currency Exchange
 Long-Run Open Economy
 Model
Event or Policy Implication