Real
Interest
Rate
Supply of loanable funds
(from national saving)
Equilibrium
real interest
rate
Demand for loanable
funds (for domestic
investment and net
capital outflow)
Equilibrium Quantity of
quantity Loanable Funds
Real
Exchange
Rate
Supply of dollars
(from net capital outflow)
Equilibrium
real exchange
rate
Real
Interest
Rate
Real Real
Interest Supply Interest
Rate Rate
r r
Real
Exchange Supply
Rate
Demand
Quantity of
Dollars
B
r2 r2
A
r r
3. . . . which in
2. . . . which
turn reduces
increases
net capital
the real Demand
outflow.
interest NCO
rate . . .
Quantity of Net Capital
Loanable Funds Outflow
Real
Exchange S S
Rate 4. The decrease
in net capital
outflow reduces
the supply of dollars
to be exchanged
E2
into foreign
E1 currency . . .
5. . . . which
causes the
real exchange
rate to Demand
appreciate.
Quantity of
Dollars
Real Real
Interest Supply Interest
Rate Rate
r r
3. Net exports,
however, remain
the same.
Demand
NCO
Quantity of Net Capital
Loanable Funds Outflow
Real
Exchange Supply
Rate
1. An import
quota increases
the demand for
E2 dollars . . .
2. . . . and
causes the E
real exchange
rate to D
appreciate.
D
Quantity of
Dollars
(a) The Market for Loanable Funds in Mexico (b) Mexican Net Capital Outflow
Real Real
Interest Supply Interest 1. An increase
Rate Rate in net capital
outflow. . .
r2 r2
r1 r1
3. . . . which D2
increases
the interest
D1
rate. NCO1 NCO2
Real
Exchange S S2
Rate 4. At the same
time, the increase
in net capital
outflow
E increases the
supply of pesos . . .
5. . . . which
E
causes the
peso to
depreciate. Demand
Quantity of
Pesos