Chapter 32 Review

Chapter 32 builds on from the topics in Chapter 21. The book talks about the two different central markets, the loanable funds market, and the market for foreign currency exchange. This chapter makes use of NCO that we learned about in the previous chapter, and using it to analyze equilibrium in an open economy. This chapter used more visuals than the last chapter, and I found it helpful. I would rate this chapter a difficulty level of 1.5/3

 Mankiw focuses on the supply and demand in both markets I went over. The market for loanable funds tells us about the equilibrium interest rate, the amount that people want to save exactly balances the desired quantities of domestic investment and net capital outflows. National savings is the supply of loanable funds, and investment and NCO are the demand. For the market of foreign currency exchange, we see that supply is just the supply of dollars to be exchanged into foreign currency to assets abroad, and the demand is the demand for dollars to buy net exports.

The key determinant of net capital outflow is the real interest rate, as reiterated again by Mankiw. If interest rates go up, savings have to be falling or investment has to be increasing, so NCO has to fall. If interest rates go down, savings have to be increasing or investment has to be falling, so NCO has to be increasing. This means that there is a negative relationship between the domestic rate of interest and the NCO according to the book. When investors change their attitudes about holding assets of a country, the ramifications for the country's economy can be profound. In particular, political instability can lead to capital flight, which tends to increase interest rates and cause the currency to depreciate.