Consider a small open economy with perfect capital mobility and a flexible exchange rate. Suppose that net capital outflow (NCO) is positive at the world interest rate. Use a two-panel graph to explain the following. (Total marks = 20)
What is the is the effect of a decrease in world interest rate on (i) national saving, (ii) domestic investment, (iii) NCO, (iv) the real exchange rate, and (v) net exports?
