Loanable Funds Market

ECON141.CHAPTER 24.

Extra note

Savers accumulateBorrowers want to make use of more funds

thanThe 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 toSupply of Loanable funds

Slight positiveAssume e is constant when graphing the

loanable funds market.

r

Loanable Funds

Investment

Saving

r0

LF0

r

Loanable Funds

DLF

SLF

r0

LF0

SLF1

r1

LF1

r

Loanable Funds

DLF

SLF

r0

LF0

DLF1

r1

LF1

r

Loanable Funds

DLF

SLF

r0

LF0

SLF1

r1

LF1

Government retires debt, freeing savings to flow to private uses.

r

Loanable Funds

DLF

SLF

r0

LF0

SLF1

r1

LF1

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

DLF

SLF

r0

LF0

DLF1

r1

LF1

Investment appears more profitable, so firms borrow more to buy capital goods.