The table below depicts the market for loanable funds in Brazil, an open economy

Question

The table below depicts the market for loanable funds in Brazil, an open economy. The currency in Brazil is the real. Real Interest Rate Demand (million reals) Supply (million reals) 10% 8 14 9% 10 14 8% 12 14 7% 14 14 6% 16 14 5% 18 14 4% 20 14 3% 22 14 2% 24 14 1% 26 14 1.) What is the autarky interest rate? 2.) If the interest rate on U.S. government bonds is 1% and the risk premium (spread) is 5%, will Brazil borrow or lend? borrow lend 3.) Is there a capital surplus or deficit? surplus deficit 4.) Now suppose the risk premium is 4%. What is the size of the capital surplus/deficit? Number million reals

Explanation / Answer

1. 7%,

autarky real interest would be 7% at this level demand is equal to supply.

2. lent

domestic market equilibrium interest rate is 7%, In US interest rate is 1% and then need 5% interest spread, so overall interest rate that US investor will demand is 6%. but in Brazil interest rate is 7% so US investor will benefit 1% by lending to brazil.

3. deficit

6% US interest rate, Brazil demand for money will be higher demand for money, so Brazil will be capital deficit state.

4. $4

at 4% risk spread demand will be 18, so capital deficit will be 4

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