Question

In late February 2020, Kuwait government took some early initiatives to control the Coronavirus pandemic. For Kuwait, the pandemic is considered to be a Double-Edged Sword, as the lower demand for oil has reduce the nation’s income and has paralyzed the domestic economic activities. Despite government support, many companies continue to lay off workers, which may lead to further reduction of national income.

4. To support the domestic economic activities, Kuwait government requested the banks to freeze the collection of mortgage payments or loans installments for six months. Using graphs explain how this policy will impact Kuwait economy's loanable funds market, net capital outflow and foreign currency market.

Answer 1

When loan repayment terms are eased out, firms will increase investment. An increase in investment (source of demand for loanable funds) will increase the demand for loanable funds. The demand curve shifts rightward, increasing both interest rate and quantity of loanable funds.

Higher domestic interest rate will decrease net capital outflow (which is inversely related to interest rates).

Since net capital outflow is equal to net exports, increase in net capital outflow will increase net exports.

Finally, as net exports increases, exchange rate decreases (which is inversely related to net exports) and domestic currency of Kuwait depreciates.

In the graph, panel A shows demand curve (investment) and supply curves (savings) for loanable funds. D0 and S0 are initial demand and supply curves intersecting at point A with initial real interest rate r0 and initial quantity of loanable funds Q0.

Panel B shows net capital outflow as an inverse function of interest rate.

Panel C shows net exports (NX) as an inverse function of exchange rate.

After increase in investment, in Panel A, D0 shifts right to D1, intersecting S0 at point B with higher interest rate r1 and higher quantity of loanable funds (savings and investment) Q1.

In panel B, higher interest rate from r0 to r1 decreases net capital outflow from NCO0 to NC01.

In panel C, decrease in NCO decreases net exports from NX0 to NX1, increasing exchange rate from e0 to e1.

X De ca ) So B (b) yo D1 NCO() DO so 31 8 NCO NCO NCO е. lo NXC) NX NXO NY