Presentation on theme: "Number of US Bank Failures"— Presentation transcript:
1Number of US Bank Failures Total No. ofYearFailed banksGA portion200731200825520091402010157212011922320125110201324FDIC usually closes banks on Fridays. Why?
2Market Rate of Interest Rate Market rate of interest performs an allocative function by assuringSSUs rate will be low enough so someone will borrow from themDSUs rate will be high enough so someone will lend to them.
3Production Opportunities In addition to Fed, interest rates affected by business opportunities (production opportunities, in book) in the economy.The lower the rate of interest, the greater the number of business ventures that should be profitable.
4Loanable Funds Sources of loanable funds consumer savings business savingslocal/state/federal government surplusescentral bank action that increases money supplyUses for loanable fundsconsumer credit purchasesbusiness investmentstate/local/federal government deficits
5Nominal vs. Real Rate of Interest Nominal interest rate is the observed rate (the market rate).Real rate of interest is nominal rate minus inflation.Prior to 6 years ago, real rate of interest had historically been between about 2% and 4%.
6Regular Fisher Equation Leti denote nominal rate of interestr denote real rate of interest (i.e., rental rate)denote expected rate of inflation.Regular Fisher equation
7Exact Fisher EquationThe three terms see to it that lender gets compensated for:rental of purchasing poweranticipated loss of purchasing power on the principalanticipated loss of purchasing power on the interest
8Example 1We lend $100 for one year under the condition that the $100 gains 5% in purchasing power. Expected inflation is 8%. What interest rate should we charge?
9Example 2Going to lend a company $3 billion to help it through a financial crisis at a rental rate of 10% plus compensation for 4% inflation. Boss says figure out interest rate to charge. What is difference between regular and exact?10/8
10Realized Real Interest Rate ex ante means based upon anticipated effects (i.e., what lies ahead)ex post means based upon analysis of past performance (i.e., what lies behind)ex ante, we assume r and forecast (expected)ex post, we know both i and (actual)Note difference between and
11Other Forms of Fisher Equations regular for ex ante use: exact for ex ante use:regular for ex post use: exact for ex post use:
12Example 3Suppose a loan were set up with a nominal interest rate of 12%. What would be realized real rate of return if inflation turned out to be 4%?approx: exact:
13When Inflation Deviates From Anticipated Inflation greater than anticipated: benefits borrowers, Results in an unintended transfer of PP from lender to borrower.Inflation less than anticipated: benefits lenders. Results in an unintended transfer of PP from borrower to lender.So what is Fisher Effect? …that embedded in nominal interest rates are inflation expectations.