Loanable Funds Market ECON141. CHAPTER 24. Extra note

 Savers accumulate  Borrowers want to make use of more funds than  The Loanable funds market brings savers and

 Savers expect to earn a  Borrowers are willing to pay a premium to acquire funds  The interest rate is the price of  Stated as a percent of

 The market rate of interest is a nominal rate (i) -  Participants in the Loanable funds market are more interested in the  The real rate is the nominal rate adjusted for  Alternatively, i =

 Savers and borrowers focus on the expected  This equals the nominal rate minus the expected r e = i -  Lenders want to be compensated for lost buying power, and borrowers are willing to

 Demand for Loanable funds depends on desire  Negatively related to  Supply of Loanable funds  Slight positive  Assume  e is constant when graphing the loanable funds market.

r Loanable Funds Investment Saving r0r0 LF 0

r Loanable Funds D LF S LF r0r0 LF 0 S LF 1 r1r1 LF 1

r Loanable Funds D LF S LF r0r0 LF 0 D LF 1 r1r1 LF 1

r Loanable Funds D LF S LF r0r0 LF 0 S LF 1 r1r1 LF 1 Government retires debt, freeing savings to flow to private uses.

r Loanable Funds D LF S LF r0r0 LF 0 S LF 1 r1r1 LF 1 Government borrows more, reducing savings available for private uses.

 In reality, government budget deficits affect the real interest rate  Why?  Foreign savings flow in,  The Fed creates money, enabling banks to make

r Loanable Funds D LF S LF r0r0 LF 0 D LF 1 r1r1 LF 1 Investment appears more profitable, so firms borrow more to buy capital goods.