Earlier this year, Greek citizens, fearing currency changes or capital controls, took billions of euros out of their bank accounts. Some of it they sent to banks in other countries, and some of it they even hid in flower pots, freezers, and yes, under mattresses. Think about all of this money flowing out of Greek banks.
a. What effect will this have on Greece’s net capital outflows? Explain.
b. What effect will this have on the real exchange rate?
It will make the real exchange rate ____________________________.
c. Draw a graph showing the relationships among net exports, net capital outflows, and the real exchange rate, where the market is in equilibrium at ε*. Show the changes you described in part “a” and “b.” Be sure to label each axis, all curves, and the initial and final real exchange rates.
d. Net capital outflows were simultaneously affected by the response of foreigners to the Greek crisis. What happened to capital inflows into Greece?
Capital inflows _________________________________.
e. Did the change in part “d” offset or exacerbate the change in the real exchange rate? Explain.