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Brief Principles of Macroeconomics...

8th Edition
N. Gregory Mankiw
ISBN: 9781337091985

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BuyFindarrow_forward

Brief Principles of Macroeconomics...

8th Edition
N. Gregory Mankiw
ISBN: 9781337091985
Textbook Problem

Suppose that real interest rates increase across Europe. Explain how this development will affect U.S. net capital outflow. Then explain how it will affect U.S. net exports by using a formula from the chapter and by drawing a diagram. What will happen to the U.S. real interest rate and real exchange rate?

To determine

The impact of increased real interest rate in Europe on the US.

Explanation

The foreign exchange market is a place where the participants are able to buy and sell different foreign currencies in exchange for the domestic currency. Here, the lonable fund interest rate theory can be applied. The lonable fund includes all the forms of credit of the economy which includes the loans, bonds, and the savings deposits. The exchange rate is the rate at which the domestic currency is exchanged for foreign currency in the foreign currency exchange market.

When the real interest rate in the Europe increases, it will attract the capital inflow from all over the world. Therefore, the US capital will also flow towards the European countries to earn higher interest rate. Hence, the increased real interest rate in the European economy increases the net capital outflow of the US economy...

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