In an individual economy that is integrated into the global market, the demand for loanable funds is determined by the country’s demand and the supply of loanable funds is determined by the world’s supply. If a country has a shortage of loanable funds at the world real interest rate, how does this situation affect the flow of loanable funds at world market?
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While the full answer to this question would depend greatly on the size of the country’s economy and the share of loanable funds that it tends to consume, we can answer the question in general terms. In general, a shortage of loanable funds in a given country will tend to pull funds to that country, thus reducing the flow of funds to other countries.
Each country that is integrated into the global financial market contributes loanable funds to the global supply and draws funds from that supply. In the country in your question, the contributions that are being made are falling short of the demands, thus causing a shortage within that country. Because there is a shortage within that country, the country needs to draw on the global pool to fulfill its needs. In such a case, that country can be imagined as a tap drawing on a common pool of water. As its tap is opened, water (funds) flows to that country. Depending on the size of the tap (how much it demands in the way of funds) and the size of the pool, it will leave more or less water to flow to other countries. However, in general, when that country’s tap opens, there will be less water (funds) to flow to those other countries.
In this way, a shortage of loanable funds in one country will affect the global flow of loanable funds by attracting more flow to that country and reducing the flow to other countries.
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