Question

According to the open economy macroeconomic model, which of the following statements is (are) correct?
(x) The usual effects of capital flight include a rightward shift of demand in the loanable funds market and a rightward shift of the NCO curve,
(y) Capital flight typically causes a decrease in the domestic interest rate and an increase in NCO.
(z) Capital flight typically causes the real exchange rate of the domestic currency to depreciate because capital flight causes an increase in the supply of the currency in foreign currency exchange markets.
A. (x), (y) and (z)

B. (x) and (y) only
C. (x) and (z) only

D. (y) and (z) only
E. (x) only

According to the open-economy macro model, which of the following causes the real exchange rate of the United States dollar to depreciate?
(x) the United States government decreases the budget deficit
(y) the United States eliminates import quotas and tariffs.
(z) capital flight from the United States
A. (x), (y) and (z)
B. (x) and (y) only
C. (x) and (z) only
D. (y) and (z) only
E. (y) only

Answer 1

1. With capital flight, there is a rightward shift in the NCO curve but no rightward shift of demand in the loanable funds market. Hence, statement X is incorrect.

Again, with capital fight, as NCO increases, domestic interest rate falls. Thus, statement Y is correct.

Similarly, with capital flight, as NCO increases, supply of domestic currency increases in the foreign currency exchange market. This leads to depreciation of the real exchange rate of the domestic currency. Thus, statement Z is correct.

Here, option D is the correct answer.

2. With decrease in budget deficit, net exports rises. As a result, NCO rises and real exchange rate of the domestic currency falls. Thus, statement X is correct.

Again, with elimination of import quotas and tariffs, net exports falls. This leads to fall in NCO and increase in real exchange rate of the domestic currency. Here, statement Y is incorrect.

Similarly, with capital flight, NCO rises and real exchange rate of the domestic currency falls. Thus, statement Z is correct.

Here, option C is the correct answer.