Why does positive NCO increase demand for loanable funds?

Question

please help me asap!

Answer 1

NCO is "net capital outflow" so that means that money is leaving the country with a positive NCO. With fewer funds available, real interest rates will rise, making it more expensive to borrow within that country.

To directly answer this question though, if NCO are increasing it is most likely that the country is a net exporter, meaning their exports are higher than imports. To increase the production within the country, firms will increase their demand for loanable funds since a lot of business expansion (investment) is done with borrowed funds. So if firms increase their borrowing, there will be an increase in demand for loanable funds within the country.

This really only applies to a country with a single currency like the US or Canada. European countries could experience different relationships since many share a single currency and some might be net importers with postivie NCO as well due to intraEU trade.

Answer 2

That is a topic that is being actively explored and debated. We're not entirely convinced that it does on its own other than net capital outflow is also part of the demand for loanable funds, (during capital flight) the demand for loanable funds rises.

Why it rises is the debatable part. Is it because due to capital flight domestic investors are looking to borrow funds to invest abroad? Is it because during periods of capital flight people are spending less domestically (savings go up), increasing the supply of loanable funds? Does it have more to do with the FX markets and how they arbitrage away the differences?

Probably a combination of all and some more.

This is the article I read to brush up on it, hopefully it sheds some light on it for you.

https://policonomics.com/lp-open-economy-loanable-funds/