Chapter 32

Chapter 32 talks about the causes of macroeconomic variables (like net exports, net capital outflow, and real/nominal exchange rates) and how they are related to each other. The first topic is of two markets and their supply and demand. These markets are the market of loanable funds and the market for foreign currency exchange. The market of loanable funds' supply curve is derived from national saving meanwhile the demand curve is derived from domestic investment and net capital outflow. At the equilibrium interest rate, the amount that people want to save exactly balances the desired quantities of domestic investment and net capital outflow. The market for foreign currency exchange's supply curve is derived from net capital outflow, meanwhile its demand curve is derived from net exports. The important determinant of net capital outflow is the real interest rate, as was said in the previous chapter. There's a negative relationship between interest rate and net capital outflow. A budget deficit reduces the supply of loanable funds which then increases the real interest rate and reduces net capital outflow. That decrease in net capital outflow reduces the supply of dollars to be exchanged into foreign currency which causes the real exchange rate to appreciate. Trade policies don't affect the trade balance. This is because they don't change national saving or domestic investment. Free trade allows everyone to be better off because everyone specializes in their what they are best at. However, trade barriers/restrictions block these gains from trade and reduce the overall economic well-being, which is why economists usually oppose trade policies. Capital flight is a big and sudden reduction in the demand for assets in a country.