Question

With the economic uncertainty and job insecurity due to the COVID-19 crisis, many consumers may increase their saving as a precautionary measure. Explain in detail the predicted long-run impact of an increase in national saving on the domestic interest rate, net capital outflow, supply and demand of domestic currency and exchange rate in a large open economy, holding other factors constant. Explain your answer clearly in words. Do not provide diagrams. (125 words maximum)

Answer 1

If the national savings increase the economic growth will be slower since increased savings implies reduced spending but in the long run as national savings increase the domestic interest rate will fall as the demand for financial market tools increase and an increase in prices of the financial assets will lead to fall in the yield or interest rates, investment will rise as the cost of borrowing falls and as the domestic interest rate falls the capital inflow will decrease compared to capital outflow as a rrsult the net capital outflow will be positive, demand for domestic currency will take a dive and supply will be higher as a result there can appreciation in the currency and the exchange rate will fall