Question

Consider the factors that affect the net exports and the net capital outflow and discuss why these two magnitudes are equal. If you consider that Turkey, has a low savings rate, which variable is to change and how would this affect the nominal and real exchange rates?

Answer 1

Factors affecting net export and net capital outflows:

Real interest rate on domestic or foreign assets; Real interest rate measure the inflation. If the real interest rate increases the money demand increased and thus this leads to inflation. This rise in real interest rate leads to fall in investment and economic growth.

Economic and political risk of holding foreign asset: Economy fluctuates every time. With respect to that, the net export and the capital inflow will change. There is a high risk for investors and other authorities who keeping this assets.

Government policies affecting foreign ownership of domestic assets: Government policies affect the capital flows. If there is high real interest rate there is low capital outflow and vice versa.

From Turkish perspective, there is a low saving rate followed there. This will affect the future of that economy. This can be increase through raising the nominal interest rate. The concept of exchange rate can be used here. When exchange rate increased, it will attract foreign customers and export become expensive and cheap imports. By raising the exchange rate, the interest rate also increased. These rises in interest rate attract the people and at the same time, the saving rate increased. Higher saving rate make the bank business to higher level. Real interest rate raises lead to fall in money demand and the precautionary demand for money increased.