Exploring Loanable Funds in Macroeconomics

Loanable Funds in Macroeconomics

Exploring the concept of loanable funds and its role in macroeconomic analysis.

Unit 4:

Financial Sector

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Topic 4.7-

The Loanable Funds

Market

Interest Rates, Borrowing, and Lending

1. Assume that the nominal interest rate is
5% and the inflation rate is 2%, what is the
real interest rate?
2. What will happen to the nominal interest
rate if the inflation rate increases to 4%?

The point- Borrowers and lenders focus
on the real interest rates since it
represents their real rate of return.

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The Loanable Funds Market
Is a real interest rate of 50% good or bad?
Bad for borrowers but good for lenders.

The loanable funds market shows the

supply and demand of loans and shows the

equilibrium real interest rate.

Demand- Inverse relationship between real
interest rate and quantity loans demanded.
Supply- Direct relationship between real interest
rate and quantity loans supplied.

This is NOT the same as the money market

(supply is not vertical).
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Loanable Funds:

• The total amount of money available for lending in the financial market

• Loanable funds refer to the pool of money that is available for borrowing and lending in the financial market.

• It plays a crucial role in determining interest rates, savings, and investment in an economy.

• Factors such as government policies, consumer preferences, and business investment decisions influence the supply and demand for loanable funds.

Real Interest

Rate

7

DBorrowers/Investors

SLenders/Savers

Loanable Funds Market

Quantity of Loans
QLoans

re

At the equilibrium real interest rate the amount

borrowers want to borrow equals the amount lenders

want to lend.

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Draw

practice drawing the loanable funds graph -

Real Interest

Rate

7

DBorrowers/Investors

SLenders/Savers

Loanable Funds Market

Quantity of Loans
QLoans

re

Reminder - money is always on the Y axis!!

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Multiple Choice

What does the concept of loanable funds refer to in macroeconomics?

• The total amount of money available for lending in the financial market

• The relationship between borrowing, lending, and economic growth

• The factors that influence the supply and demand for loanable funds

• The analysis of interest rates, savings, and investment

Saving and Supply

Saving is what makes lending possible so the supply of loanable funds is the amount of money that is saved.

Private Saving- the amount that households save instead of consume.

Public Saving- the amount that the government saves instead of spends.
i
National Savings = public + private saving

A change in public or private saving will

shift the supply of loanable funds.

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Factors Affecting Loanable Funds

• Interest Rates: Higher rates increase supply
• Income Levels: Higher incomes increase supply
• Government Policies: Regulations affect supply
• Investor Confidence: Positive sentiment increases supply

Real

Interest

Rate

9

SLenders

Loanable Funds Market

Quantity of Loans
QLoans

S1

re

r1

Q1

Example: The Gov’t increases taxes on interest from savings.

Public savings and the supply of loanable funds falls.

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DBorrowers/Investors

Interest Rates

Interest rates play a crucial role in determining the supply of loanable funds. When interest rates are high, lenders are more willing to supply funds, as they can earn higher returns. Conversely, when interest rates are low, lenders may be less inclined to supply funds, as the potential returns are lower. This relationship between interest rates and supply is a key factor in macroeconomics.

Foreigners and Supply

Foreigners also lend so the supply of
loanable funds also depends the amount of
money that enters or leaves the country.

Capital Inflow- the amount of money entering the country.

Capital Outflow- the amount of money leaving the country.

Net Capital Inflow = inflow - outflow


A change in net capital inflow will shift the supply of loanable funds

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Multiple Select

Which factor affects supply in the context of loanable funds in macroeconomics?

• Interest Rates

• Income Levels

• Capital Flow

• Government deficit spending

Investing and Demand

Borrowing is the demand of loanable funds.

Private Investment- borrowing by businesses and consumers.

Government Borrowing- deficit spending when government spending is greater than tax revenue.

A change that effects borrowing will shift

the demand of loanable funds.

(For example: investment tax credits)

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Factors Affecting Demand

• Interest Rates: Higher interest rates increase the cost of borrowing, reducing demand for loanable funds.
• Economic Conditions: During economic downturns, businesses and individuals may reduce borrowing, decreasing demand.
• Government Policies: Changes in regulations or taxes can impact borrowing behavior and demand for loanable funds.
• Investment Opportunities: Availability of profitable investments can influence demand for loanable funds.

Interest Rates

• Interest rates play a crucial role in influencing the demand for loanable funds.
• When interest rates are low, the demand for loanable funds tends to increase as borrowing becomes more affordable.
• Conversely, when interest rates are high, the demand for loanable funds tends to decrease as borrowing becomes more expensive.

Real Interest

Rate

50

DBorrowers

SLenders

Loanable Funds Market

Quantity of Loans
QLoans

D1

re

r1

Q1

Example: The Gov’t increases deficit spending?

Government borrows from private sector

Increasing the demand for loans and increasing the interest rate

Real interest
rates increase

causing

crowding out!!

Multiple Select

What factors can influence the demand for loanable funds?

• Interest Rates

• Inflation Rates

• Exchange Rates

• Government defecit spending

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Loanable Funds Market

1. Changes in private

savings behavior

2. Changes in public

savings

3. Changes in foreign

investment (ex: more
inflow of foreign
financial capital)

1. Changes in borrowing

by consumers

2. Changes in borrowing

by businesses
(investment spending)

3. Changes in borrowing

by the government
(ex: deficit spending)

Demand Shifters

Supply Shifters

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Demand for loans comes from borrowers/investors

Supply for loans comes from lenders/savers

Categorize

Options (8)

capital inflow from higher %

increase taxes on savings

Government deficit spending

higher price levels

expectations of a recession

tax credits for Investing (I)

mpc increases

interest rates for trading partner increase

Organize these options into the right categories

Decrease Demand

Increase Demand

Increase Supply

Decrease Supply

What will happen to the demand and supply for

loanable funds if there is political instability?

Demand and supply

both shift

-Demand will decrease
as worried consumers
and businesses
borrow/invest less

-Supply will decrease
as worried foreigners
take money out of the
country (This is called
“capital flight”)

Quantity of loans falls

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D1

Real
IR

Quantity of Loans

S

irR

D

S1

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Let’s Compare and Contrast the Money

Market and Loanable Funds Graphs

1. Why is the supply of money vertical?
2. What shifts the supply of money?
3. Why is the supply of loanable funds upward sloping?
4. What shifts the supply of loanable funds?
5. Why is the demand for money downward sloping?
6. What shifts the demand for money?
7. Why is the demand for loanable funds downward sloping

8. What shifts the demand for loanable funds?
9. What kind of interest rate is on the money market graph

10. What kind of interest rate is on the loanable funds graph?

Hotspot

Assume the U.S. is in long run equilibrium. Draw the correctly labeld graph of AD/AS.

a) Assume the government increases spending on the military without increasing taxes - show on your graph

b) if the economy self-adjusts in the long run, explain the change to both SRAS and Employment

c) To pay for (a) assume the government borrows the money. Show the affect on the loanable funds graph

d) given the affect on real interest from (c), what will happen to

i. Investment (I)

ii. economic growth