Question

In the open-economy macroeconomic model, if the supply of loanable funds shifts right

Group of answer choices

the interest rate falls and the supply of dollars in the market for foreign-currency exchange shifts right.

the interest rate falls and the supply of dollars in the market for foreign currency exchange shifts left.

the interest rate rises and the demand for dollars in the market for foreign currency exchange shifts right.

the interest rate rises and the demand for dollars in the market for foreign currency exchange shifts left.

Answer 1

As the supply of loanable funds increases in the money or loanable funds market in an open economy, the value or the price of money or loanable funds in the market decreases, holding everything else constant. As the supply of money or loanable funds is higher that the existing money or loanable funds demand due to the increase in the supply of loanable funds creating excess supply of money/loanable funds, the value/price of money/loanable funds or the interest would decrease and not increase. It would have risen or increased if there had been excess demand for money or lonable funds than the supply level for any corresponding fluctuations or shifts in both. Now, as the interest rate decreases, the value of the domestic currency would decrease or the exchange rate of the currency would depreciate which would expectedly result in higher demand for domestic goods and services among the foreign residents or citizens as now the domestic goods and services have become cheaper in the international market due to the depreciation of the domestic currency. Furthermore, a decrease in the interest rate also implies that the financial return from investment on any domestic asset has also decreased among the investors in the international financial market. Therefore, the investors would increase the supply of domestic currency or dollars in the market or more investors would be willing to supply the domestic currency or dollars. Hence, the supply of dollars would shift to the right in the foreign exchange rate for dollars. Now, since the interest rate in the money or lonable funds decreases due to the increase in loanable funds supply, the last two options given in the answer options would be wrong, in this case. Further, as interest rate in the domestic economy declines, the rate of return on any financial investment on any domestic financial asset would also decrease consequently thereby reducing the demand for domestic financial assets among the foreign investors which would impel to release or withdraw the domestic currency or dollars by the investors as its exchange rate value and demand among the investors have decreased leading to an increase and not decrease in the supply of domestic currency or dollars. Thus, the answer, in this case would be the first option given in the answer choices or options or the interest rate falls and the supply of dollars in the market for foreign-currency exchange shifts right.