Loanable Funds Market Module 29

Market for Loanable Funds... Real Interest Rate Supply (savings) Demand (borrowing) 4% $1,000 Loanable Funds (in billions of dollars) 2

What is this graph measuring? The real interest rate and the quantity of loanable funds What does quantity of loanable funds refer to? The amount of money that is available in the financial markets to be borrowed Why is the real interest rate on the vertical axis? It is the price or cost of borrowing and it is the income received from lending What does “real” rate mean? The interest rate with inflation accounted for (nominal rate – inflation rate = real rate)

Market for Loanable Funds... Real Interest Rate Supply (savings) 4% $1,000 Loanable Funds (in billions of dollars) 2

Supply of Loanable Funds Where do the supply of loanable funds come from? Savers Who are the savers? Households Government Businesses ROW (Rest of the World) How do interest rates affect savings? The higher the rate the higher the QS

Market for Loanable Funds... Real Interest Rate Demand (borrowing) 4% $1,000 Loanable Funds (in billions of dollars) 2

Demand for Loanable Funds Where does the demand for loanable funds come from? Borrowers Who are the borrowers? Households Government Businesses for Investment Spending ROW (Rest of the World) How do interest rates affect borrowing? The lower the rate the higher the QD

Market for Loanable Funds... Real Interest Rate Supply (savings) Demand (borrowing) 4% $1,000 Loanable Funds (in billions of dollars) 2

Equilibrium in the Loanable Funds Market Where is equilibrium? At the interest rate that equates the quantity supplied and quantity demanded What happens if the interest rate is higher than the equilibrium? There will be a surplus of funds available which will force the interest rate down What happens if the interest rate is lower than the equilibrium? There will be a shortage of funds available which will force the interest rate up

Market for Loanable Funds... Real Interest Rate Demand 2 Supply (savings) Demand 1 Demand 3 5% 4% $1,000 3% $900 $1,100 Loanable Funds (in billions of dollars) 2

Changes in the Demand for Loanable Funds What would cause a change in what businesses are spending? Changes in their profit expectations Changes in tax law What would cause a change in what government is spending or saving? Changes in need to borrow (business cycle changes) Changes in tax collections

Market for Loanable Funds... Supply 3 Real Interest Rate Supply 1 Demand (borrowing) Supply 2 5% 4% $1,000 3% $900 $1,100 Loanable Funds (in billions of dollars) 2

Changes in the Supply of Loanable Funds Market What determines the Supply of Loanable Funds? Savings Where do savings come from? From the income not spent What would cause the amount of savings to change? Changes in private savings (wealth, income, age) Changes in capital inflows (foreign savings) Changes in expected inflation (Fisher effect)