Capital Inflows: Foreign Savers Buy In
Saving from abroad flows into domestic bonds, adding to the supply of loanable funds and pulling the real interest rate down.
Capital Inflows: Foreign Savers Buy In
Loanable Funds MarketSaving from abroad flows into domestic bonds, adding to the supply of loanable funds and pulling the real interest rate down.
Equilibrium at Quantity of Loanable Funds 73, Real Interest Rate (%) 5
Start at Equilibrium
The market begins in equilibrium, with the real interest rate on the vertical axis and the quantity of funds on the horizontal axis. In an open economy the supply of loanable funds is not just domestic saving: anyone willing to lend here counts, including savers living abroad who buy domestic bonds.
Now try it yourself: shift the curves in a graded FRQ drill, or open this graph in the free sandbox.
Students predict what happens before the graph moves. No accounts, nothing graded.
Capital Inflows: Foreign Savers Buy In, step by step
- 1
Start at Equilibrium
The market begins in equilibrium, with the real interest rate on the vertical axis and the quantity of funds on the horizontal axis. In an open economy the supply of loanable funds is not just domestic saving: anyone willing to lend here counts, including savers living abroad who buy domestic bonds.
- 2
Foreign Saving Pours In
Political stability and reliable courts make domestic bonds look attractive, so investors abroad convert currency and lend here. These lenders add funds at every real interest rate, and the supply of loanable funds shifts right. Domestic households have not changed their own saving behavior, and no borrower's plans have changed, so demand holds still.
- 3
The Real Interest Rate Falls
The larger pool of lending pushes the equilibrium down along the demand curve. The real interest rate falls and the equilibrium quantity of funds borrowed and lent rises. Domestic borrowers are better off not because their demand changed but because they now face a cheaper price for funds.
- 4
Domestic Borrowers Finance More
Cheaper credit means firms finance capital projects that the old real interest rate ruled out, a movement down along the demand curve. Connect this to the balance of payments: the financial account inflow that lowered the real interest rate has a matching current account deficit on the other side of the ledger. Foreign saving is financing domestic capital rather than domestic saving doing it.
Where it ends up
An inflow of foreign saving shifts the supply of loanable funds right, lowering the real interest rate and raising the quantity of funds borrowed and invested.
Now draw it yourself
Same graph, graded on whether you move the right curve and leave the rest alone.
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