Chapter 32/ Level of difficulty 2/3

Two markets are key to an open economy, those being the loanable funds market and the market for foreign-currency exchange. The real interest rate will adjust to fix the supply in the market for loanable funds from national savings and the demand, from domestic investment and net capital outflow. The market for foreign-currency exchange on the other hand the real exchange rate adjusts to balance the supply of dollars coming from net capital outflow and the demand for dollars, for net capital exports. Net capital is a shared variable in both markets, thus it is the connection amongst them. A policy may be imposed by the government and will decrease the amount of supply, but drive interest rates up. Higher interest levels reduce net capital outflow which would then reduce the amount of dollars in a foreign-currency exchange market. If the dollar would appreciate then there would be a fall in net exports. Some trade policies are designed to alter trade balance, such as tariffs , quotas and etc, but may not have such effects.