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Capital outflow accompanies policy actions where it reflects outward investment opportunities, financial integration, and increased liberalization.
It is studied by policymakers to identify drivers for the economy's financial crisis, growth factors, inflation, asset price, and exchange rates.
Since the global financial crisis, there has been much focus on gross capital inflows and outflow and their sum.
Most countries need to manage their capital flows to benefit from the implementation of macroeconomic policies.
The government needs to implement time structural reforms to build sound institutions that can withstand shocks and manage outflow safely.
Net capital outflows or NCOs – or the net foreign investment provides a difference between the acquisition of foreign assets by domestic residents and the acquisition of such assets by a foreign national.
This is related to saving the loanable fund and foreign currency exchange.
The relation between NCO and foreign exchange is used in an open economy.
Even in the absence of a financial crisis, large unpredicted outflows can pose significant policy challenges.
Sometimes, domestic vulnerabilities and international factors like global risk sentiments and liquidity drive such disruptive outflows.
Even a short crisis can lead to large sudden outflows and this can affect the exchange rates, credit, interest rates, and output.
In the market of the loanable fund, all savers come to deposit their savings, and saving corresponds to everything the economy saves – in the private or government sector.
This is represented as national savings that are supplied to the market, while, we have national investment and net capital outflow on the other side as demand. It is necessary to establish an equilibrium between the two.
If the economy is running a trade deficit, finance is gained by selling assets abroad.
In the European Union, one requires Euros to buy assets. If the resident buys overseas, they need to compare the exchange rate of Euros for the foreign currency.
The state of equilibrium is established by the real exchange rate as it corresponds to the relative price of domestic and foreign goods. NCO links both the markets.
The NCO curve slopes downwards because of the increase in domestic real interest rates that makes the country’s assets more attractive and with higher foreign investment, the NCO reduces.
The government aims to create equilibrium where import quotas are determined and this makes the foreigners to buy more Euros to buy EU net exports.
It is caused by political instability, where large quantities of assets leave the economy and this can shift the NCO curve, and the market of foreign currency exchange where the residents use the exchange to convert the local money into more secure alternative currencies, shifting the supply curve.
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