Open Economy Macro: II

1. Loanable Funds Market

• S = I + NCO (supply = demand) [assuming G = T]
• See the FYI box on page 723

2. Foreign exchange market

• NCO = NX(E) (supply = demand)

3. Equilibrium in the two markets

• NCO = f(r)

4. Comparative statics

• A budget deficit reduces the supply of loanable funds, S + (G - T) = I + NCO, and increases a trade deficit.
• Protectionist trade policy (e.g., import quota) increases the demand for dollars, NCO = NX (supply = demand), but doesn't affect the balance of trade.