Question: How are the identities S = NCO + I and NCO = NX related to the foreign currency exchange market and the loanable funds market? Edit
Answer: S implies national saving, which is the source of loanable funds supply in the economy. Demand comes from net capital outflow (NCO) and domestic investment (I) and the real interest rate balances demand and supply.
In the market for foreign currency exchange, NCO is net capital outflow which is the source of supply in the foreign-currency exchange market. NX is net exports, which is the source of demand in the foreign-currency exchange market and the real exchange rate balanced demand and supply.
NCO is the variable that links these two markets. In the market for loanable funds, NCO influences demand. A person who wants to buy an asset abroad must finance this purchase by borrowing from the market of loanable funds. In the market for foreign currency exchange, NCO is the source of supply. A person who wants to buy an asset in another country must supply their own currency to exchange them for the currency of that country.
Thus, NCO is the link between the market for loanable funds and the market for foreign-exchange market. Edit
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