IV. The Global Loanable Funds Market

International Capital Mobility

• The loanable funds market is a global market. Lenders look worldwide to find the highest real interest rate; borrowers likewise look worldwide to find the lowest real interest. These actions bring the risk-adjusted real interest rate to equality throughout the world.
• If a country’s net exports are negative, X < M, then the country finances the shortfall in exports by borrowing from the rest of the world. If a country’s net exports are positive, X > M, then the country uses the excess to loan to the rest of the world.

Demand and Supply in Global and National Markets

• Demand and supply in the world global loanable funds market determines the world equilibrium real interest rate.
• A country is a net foreign borrower if the world equilibrium real interest rate is less than what would be the no-trade interest rate in the country. The figure shows this situation.

· In the figure, when the country is isolated from international trade the equilibrium real interest rate would be 6 percent and the equilibrium quantity of loanable funds would be $1.6 trillion.

· With international trade, the real interest rate in the country becomes the world real interest rate, 5 percent. At this lower real interest rate, the quantity of loanable funds supplied decreases to $1.4 trillion and the quantity of loanable funds demanded increases to $1.8 trillion. The difference, $0.4 trillion, is borrowed from abroad. The country has negative net exports, with X < M.

• A country is a net foreign lender if the world equilibrium real interest rate exceeds what would be the no-trade interest rate in the country. The figure shows this situation.

· In the figure, when the country is isolated from international trade the equilibrium real interest rate would be 4 percent and the equilibrium quantity of loanable funds would be $1.6 trillion.

· With international trade, the real interest rate in the country becomes the world real interest rate, 5 percent. At this higher real interest rate, the quantity of loanable funds supplied increases to $1.8 trillion and the quantity of loanable funds demanded decreases to $1.4 trillion. The difference, $0.4 trillion, is loaned abroad. The country has positive net exports, with X > M.

• In a small country, changes in the national demand and supply of loanable funds change the country’s international loaning or borrowing and will change the country’s net exports.

Date: 2015-12-11; view: 1943