Which Investment? Saudi U.A.E.Nominal Rate 10% 12% Inﬂation 4% 7% Real Rate 6% 5%
Market for Loanable Funds Real Interest Too high Rate More supply than demand push rate down Supply From national savings Equilibrium Rate Demand For domestic and foreign Too low investment More demand than supply push rate up Equilibrium Quantity Quantity of Loanable Funds
Foreign Currency Exchange Market NCO = NXNet Capital Outﬂow = Net Exports
Foreign Currency Exchange Market If NX > 0 Selling more than buying What to do with cash? Must buy foreign assetsRemember foreign currency is a foreign asset
Foreign Currency Exchange Market If NX < 0Buying more than sellingMust sell domestic assets to pay for purchases
Foreign Currency Exchange MarketAt the Equilibrium Exchange Rate: Demand for currency from foreigners from net exports = Supply of currency from citizens from net capital outﬂow
Market for Foreign Currency Exchange High rates discourage exports Real SupplyExchange From net capital outﬂow Vertical - does not depend on Rate exchange rate Equilibrium Rate Low rates stimulate exports Too high Demand More supply than demand For net exports Pressure to push rate down Too low More demand than supply Pressure to push rate up Equilibrium Quantity Quantity of Riyals Exchanged into Foreign Currency
LinkingThe Loanable Funds Market S = I + NCO withForeign Currency Exchange Market NCO = NX
Where did the riyals come from? Saudi SaversLoanable Funds Market Where did I buy the riyals?Foreign Currency Market Currency Tradersmove funds between the two markets
Net Capital OutﬂowDepends on Real Interest Rate RealInterest Rate NCO is negative 0 NCO is positive NCI is positive NCI is negative Cash comes in Cash goes out
Linking Loanable Funds Market Net Capital Outﬂow Real Supply Real Interest Interest Rate RateEquilibrium Interest Rate Demand Demand Quantity of Loanable Funds Quantity of Loanable FundsLoanable Funds Market Interest Rate Real Exchange Rate Supply Equilibrium Exchange RateForeign Currency Market Demand Exchange Rate Quantity of Riyals Foreign Currency Exchange Market
Policy Loanable Funds Market Net Capital Outﬂow Real Supply Real Interest Interest Rate RateEquilibrium Interest Rate Demand Demand Quantity of Loanable Funds Quantity of Loanable Funds Government deﬁcits Real Supply push up interest rates Exchange Rate which increase Equilibrium exchange rates Exchange Rate which increase trade Demand deﬁcits Quantity of Riyals Foreign Currency Exchange Market
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