Page 667 - The Principle of Economics

CHAPTER 30 A MACROECONOMIC THEORY OF THE OPEN ECONOMY 685
NET FOREIGN INVESTMENT:
THE LINK BETWEEN THE TWO MARKETS
We begin by recapping what we’ve learned so far in this chapter. We have been discussing how the economy coordinates four important macroeconomic vari- ables: national saving (S), domestic investment (I), net foreign investment (NFI), and net exports (NX). Keep in mind the following identities:
and
S 􏰀 I 􏰁 NFI
NFI 􏰀 NX.
In the market for loanable funds, supply comes from national saving, demand comes from domestic investment and net foreign investment, and the real interest rate balances supply and demand. In the market for foreign-currency exchange, supply comes from net foreign investment, demand comes from net exports, and the real exchange rate balances supply and demand.
Net foreign investment is the variable that links these two markets. In the mar- ket for loanable funds, net foreign investment is a piece of demand. A person who wants to buy an asset abroad must finance this purchase by borrowing in the mar- ket for loanable funds. In the market for foreign-currency exchange, net foreign in- vestment is the source of supply. A person who wants to buy an asset in another country must supply dollars in order to exchange them for the currency of that country.
The key determinant of net foreign investment, as we have discussed, is the real interest rate. When the U.S. interest rate is high, owning U.S. assets is more attractive, and U.S. net foreign investment is low. Figure 30-3 shows this negative
Real Interest Rate
Figure 30-3
HOW NET FOREIGN INVESTMENT DEPENDS ON THE INTEREST RATE. Because a higher domestic real interest rate makes domestic assets more attractive, it reduces net foreign investment. Note the position of zero on the horizontal axis: Net foreign investment can be either positive or negative.
Net foreign investment 0 is negative.
Net foreign investment is positive.
Net Foreign Investment