Beruflich Dokumente
Kultur Dokumente
r*
Market for S - I(r*) = NCO(r*)
Loanable Funds
Market for
Foreign Exchange
NX(e)
Real Exchange Rate, e
3
Small Open Economy
Real NCO(r*)
Interest Real
Rate S(r) Exchange NCO(r*)
Rate
r*
e*
NX(e)
I(r)
0Foreign Exchange
Loanable Funds
4
Policy 1: Domestic Govt Deficit
Increase in Domestic Govt Budget Deficit of a small open economy.
Govt Budget Deficit reduces Loanable Funds Supply.
Results:
1. Real interest rate fixed at ROW level, r*.
2. NCO falls, reducing Supply of Foreign Exchange.
3. NX(e) does not shift, thus real exchange rate, e*, appreciates.
Changes in gov't deficit thus do not affect real interest rate or investment
but do affect the real exchange rate and Net Exports.
5
Domestic Deficit Diagrams
Real
Interest NCO1(r*)
Real NCO0(r*)
Rate S1 S0 Exchange
Rate 2
1
r* e1
3
e0
NX(e)
I(r)
6
Policy 2: Foreign Govt Deficits
r*1
1 e0
r*0 3
e1
NX(e)
I(r)