Net Capital Outflow
Encyclopedia
Net Capital Outflow is the net flow of funds being invested abroad by a country during a certain period of time (usually a year). A positive NCO means that the country invests outside more than the world invests in it; a negative one, that the world invests in the country more than the country invests in the world. NCO is one of two major ways of characterizing the nature of a country's financial and economic interaction with the rest of the world (the other being the balance of trade
).
and the international currency exchange
market. This relationship is often summarized by graphing the NCO curve with the quantity of country A's currency in the x-axis and the country's domestic real interest rate
in the y-axis. The NCO curve gets a negative slope because an increased interest rate domestically means an incentive for savers to save more at home and less abroad.
NCO also represents the quantity of country A's currency available on the foreign exchange market
, and as such can be viewed as the supply-half that determines the real exchange rate, the demand-half being demand for A's currency in the foreign exchange market. As can be seen in the graph, NCO serves as the perfectly inelastic supply curve for this market. Thus, changes in the demand for A's currency (e.g. change from an increase in foreign demand for products made in country A) only cause changes in the exchange rate and not in the net amount of A's currency available for exchange.
By an accounting identity, Country A's NCO is always equal to A's Net Exports, which is also equal to the net amount of A's currency traded in the foreign exchange market over that time period. The value of exports (bananas, ice cream, clothing) produced in country A is always matched by the value of reciprocal payments of some asset (cash, stocks, real estate) made by buyers in other countries to the producers in country A. This value is also equal to the total amount of A's currency traded in the foreign exchange market over that year, because essentially the buyers in other countries trade in their assets (e.g. foreign currency) to convert to equivalent amount in A's currency, and use this amount to pay for A's export products.
Y - C - G = I + NX
S = I + NX
NX = NCO therefore
S = I + NCO
Balance of trade
The balance of trade is the difference between the monetary value of exports and imports of output in an economy over a certain period. It is the relationship between a nation's imports and exports...
).
Explanation
NCO is linked to the market for loanable fundsLoanable funds
In economics, the loanable funds market is a hypothetical market that brings savers and borrowers together, also bringing together the money available in commercial banks and lending institutions available for firms and households to finance expenditures, either investments or consumption...
and the international currency exchange
Currency exchange
Currency exchange can refer to:* Bureau de change* Foreign exchange market...
market. This relationship is often summarized by graphing the NCO curve with the quantity of country A's currency in the x-axis and the country's domestic real interest rate
Real interest rate
The "real interest rate" is the rate of interest an investor expects to receive after allowing for inflation. It can be described more formally by the Fisher equation, which states that the real interest rate is approximately the nominal interest rate minus the inflation rate...
in the y-axis. The NCO curve gets a negative slope because an increased interest rate domestically means an incentive for savers to save more at home and less abroad.
NCO also represents the quantity of country A's currency available on the foreign exchange market
Foreign exchange market
The foreign exchange market is a global, worldwide decentralized financial market for trading currencies. Financial centers around the world function as anchors of trading between a wide range of different types of buyers and sellers around the clock, with the exception of weekends...
, and as such can be viewed as the supply-half that determines the real exchange rate, the demand-half being demand for A's currency in the foreign exchange market. As can be seen in the graph, NCO serves as the perfectly inelastic supply curve for this market. Thus, changes in the demand for A's currency (e.g. change from an increase in foreign demand for products made in country A) only cause changes in the exchange rate and not in the net amount of A's currency available for exchange.
By an accounting identity, Country A's NCO is always equal to A's Net Exports, which is also equal to the net amount of A's currency traded in the foreign exchange market over that time period. The value of exports (bananas, ice cream, clothing) produced in country A is always matched by the value of reciprocal payments of some asset (cash, stocks, real estate) made by buyers in other countries to the producers in country A. This value is also equal to the total amount of A's currency traded in the foreign exchange market over that year, because essentially the buyers in other countries trade in their assets (e.g. foreign currency) to convert to equivalent amount in A's currency, and use this amount to pay for A's export products.
Equation
Y = C + I + G + NX - Accounting Identity for GDPY - C - G = I + NX
S = I + NX
NX = NCO therefore
S = I + NCO