1  The Determinants of the Interest Rate The Determinants of the Interest Rate  Inflation and Interest Rates Inflation and Interest Rates  The Cyclical Movement of Interest Rates The Cyclical Movement of Interest Rates

2 The Determinants of the Interest Rate  Changes in the interest rate influence the behavior of net borrowers and net lenders.  In the market for loanable funds, supply and demand are the key to determining interest rates in equilibrium.  利率的变化会影响借方和贷方的行为，但最 终的均衡利率是由借方的需求和贷方的供给 共同决定。

3 Interest rate: stocks and flows  In chapter 3, interest rate is determined by the demand and supply of money. The supply of and demand for money are both measured at a point in time and refer to actual stocks.

4 stocks and flows  When there is a change in a stock measured at different times, a flow has occurred, that is,a flow over time results in a change in a stock.  A theory stated in stocks can always be reformulated in terms of flows and vice versa.  Loanable funds model deals with flows of loanable funds over time.

5 On the borrower side  The demand for loanable funds originates from household, business, government, and foreign net borrowers 可贷资金需求：来自于个人、企业、政府或国外部门的借款需求。  they are spending more than their current income  Net borrowers are willing to borrow more at lower interest rates, ceteris paribus  the demand for loanable funds will be downward sloping

6 On the lender side  The total supply of loanable funds originates from two sources: 可贷资金供给：可供借贷的资金来自两方面： （ 1 ）个人、企业、政府或国外贷方 （ 2 ）联储的准备金供给  household, business, government, and foreign net lenders  they spend less than their current income  the Fed  supplies reserves to the financial system that lead to increases in the growth rate of money and loans  assume that this is fixed (for now)

7  Net lenders are willing to supply more funds at higher interest rates  the supply of loanable funds will be upward sloping

8 The Determinants of the Interest Rate  The equilibrium interest rate occurs where the quantity of funds supplied is equal to the quantity of funds demanded

9 The Supply of and Demand for Funds Interest Rate (Percent) Loanable Funds (in Billions) Demand Supply $500 E1E1 6

10 Changes in the Demand for Loanable Funds  Movements in GDP are a major determinant of shifts in the demand for funds  when GDP rises, firms and households are more willing and able to borrow  Another factor that affects the demand for loanable funds is an increase in the expected productivity of capital investments

11 A Shift in the Demand for Funds Interest Rate (Percent) Loanable Funds (in Billions) DD $500 E1E1 Supply 6 $600 8 E2E2 D’D’

12 Changes in the Supply of Loanable Funds  One of the factors affecting the supply of funds is monetary policy  the Fed’s ability to alter the growth rate of money in the economy means that it can have a direct effect on the cost and availability of funds

13 A Shift in the Supply of Funds Interest Rate (Percent) Loanable Funds (in Billions) Demand $500 E1E1 SS 6 $550 4E2E2 S’S’

14 The Determinants of the Interest Rate  The determinants of interest rates can be summarized as follows i = f (Y +, M - )  the interest rate is a positive function of income or GDP (Y) and a negative function of the money supply (M)  an increase in Y increases the demand for funds  an increase in M increases the supply of funds

15 Inflation and Interest Rates  Lenders are concerned with two things  nominal interest  how many dollars will be received in the future in return for lending now  inflation  the real purchasing power the funds will be worth upon repayment

16 Inflation and Interest Rates  The market interest rate (the nominal interest rate 名义利率 ) is not an adequate measure of the real return on an interest- bearing asset  The appropriate measure is the real interest rate （实际利率）  the return on the asset corrected for changes in the purchasing power of money  the nominal interest rate minus the expected rate of inflation

17 Inflation and Interest Rates i = r + p e  The inflation premium （通货膨胀补偿） is the amount of nominal interest that will compensate a lender for the expected loss of purchasing power accompanying any inflation  equal to the expected inflation rate (p e )  Nominal interest rates rise and fall as expected inflation rises and falls

18 Example  Suppose that the commercial paper rate is 5% and the current expected rate of inflation is 3%  the expected real interest rate is 2%  If borrowers and lenders expect the inflation rate to be 6%, the expected real interest rate becomes -1%  this drop in the real cost of borrowing and real return on lending will increase the demand for funds and lower the supply of funds

19 The Supply of and Demand for Funds Interest Rate (Percent) Loanable Funds (in Billions) DD E1E1 SS 5 $500 E2E2 8 D’D’ S’S’

20 The Determinants of the Interest Rate  We can now summarize the determinants of interest rates as follows i = f (Y +, M -, p e + )  the nominal interest rate is positively related to the expected inflation rate

21 The Cyclical Movement of Interest Rates  During a recession, income and GDP fall and the Fed may attempt to stabilize the economy by increasing the money supply  reduces the demand for funds  increases the supply of funds  a drop in the inflation rate  The result is a decline in the interest rate

22 The Cyclical Movement of Interest Rates  During an expansion, income and GDP rise and the Fed may attempt to slow the growth rate of the money supply  increases the demand for funds  decreases the supply of funds  inflation usually reaccelerates  The result is a rise in the interest rate

23 Summary of Major Points  The interest rate is the return on lending today (spending in the future) and the cost of borrowing today (repaying in the future)  the interest rate represents the time value of money and specifies the terms under which one can trade present purchasing power for future purchasing power

24 Summary of Major Points  Compounding answers the question: what is the future value of money lent today?  it is the increase in the future value of funds from earning interest on interest  Discounting answers the question: what is the present value of money to be received in the future?  here again the interest rate links the present with the future

25 Summary of Major Points  A bond is a stream of future payments  the price of a bond will be equal to the present value of the discounted future stream of income  when the interest rate changes, this present value will change also  when the interest rate rises, the price of outstanding bonds will fall  when the interest rate fall, the price of outstanding bonds will rise

26 Summary of Major Points  Ceteris paribus, the quantity demanded of loanable funds is inversely related to the interest rate  Ceteris paribus, the quantity supplied of loanable funds is positively related to the interest rate

27 Summary of Major Points  Changes in interest rates are the result of changes in the supply of and/or demand for funds  the demand for funds is positively related to income and positively related to anticipated increases in the productivity of capital investment  the supply of funds is positively related to the money supply

28 Summary of Major Points  The nominal interest rate (i) is composed of a real interest rate (r) and an inflation premium reflecting the expected inflation rate (p e ) i = r + p e  The determinants of the interest rate can be summarized as i = f (Y +, M -, p e + )

29 Summary of Major Points  The consumer price index (CPI) measures changes in the cost of goods and services purchased by a typical urban consumer  The producer price index (PPI) measures the change in the cost of goods and services purchased by a typical producer  The inflation rate is generally measured by the percentage change in one of these price indexes

30 Summary of Major Points  Interest rates tend to fluctuate procyclically  during a recession, income and GDP fall  as an expansion takes hold, income and GDP rise  A consol is a perpetual bond with no maturity date  the price of a consol is equal to the coupon payment divided by the nominal interest rate