Loanable Funds Market Module 29 Market for Loanable

Loanable Funds Market Module 29

Market for Loanable Funds. . . Real Interest Rate Supply (savings) 4% Demand (borrowing) 0 $1, 000 Loanable Funds (in billions of dollars)

• 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% 0 $1, 000 Loanable Funds (in billions of dollars)

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 4% Demand (borrowing) 0 $1, 000 Loanable Funds (in billions of dollars)

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) 4% Demand (borrowing) 0 $1, 000 Loanable Funds (in billions of dollars)

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 Supply (savings) 5% 4% 3% Demand 2 Demand 1 Demand 3 0 $900 $1, 000 $1, 100 Loanable Funds (in billions of dollars)

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 Supply 2 5% 4% 3% Demand (borrowing) 0 $900 $1, 000 $1, 100 Loanable Funds (in billions of dollars)

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)