1. Loanable Funds Market
Module 29

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

3. 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)

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

5. 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

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

7. 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

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

9. 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

10. 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

11. 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

12. 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

13. 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)