Loanable Funds Market

1
Loanable Funds Market
ECO 105 Lecture 3.9 31 October 2008
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The Market for Loans

• Savers accumulate
• Borrowers want to make use of more funds than
• The loanable funds market brings savers and

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The Price of Loanable Funds

• 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

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Nominal and Real Interest Rates

• 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

5

• 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

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Loanable Funds Market

• Demand for loanable funds depends on desire
• Negatively related to
• Supply of loanable funds
• Slight positive
• Assume pe is constant when graphing the loanable
  funds market.

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Graph of LF Market
r
Saving
r0
Investment
Loanable Funds
LF0
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Introduce Tax-deferred Savings Accounts
SLF
r
1
SLF
r0
r1
DLF
Loanable Funds
LF0
LF1
9
Introduce Investment Tax Credits
SLF
r
r1
r0
1
DLF
DLF
Loanable Funds
LF0
LF1
10
Increased Government Budget Surplus (or smaller
deficit)
SLF
r
1
SLF
Government retires debt, freeing savings to flow
to private uses.
r0
r1
DLF
Loanable Funds
LF0
LF1
11
Increased Government Budget Deficit
1
SLF
SLF
r
Government borrows more, reducing savings
available for private uses.
r1
r0
DLF
Loanable Funds
LF0
LF1
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Caveats Foreign Savings and Federal Reserve
Policy

• In reality, government budget deficits affect the
  real interest rate
• Why?
• Foreign savings flow in,
• The Fed creates money, enabling banks to make

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Expected Capital Productivity Increases
SLF
r
Investment appears more profitable, so firms
borrow more to buy capital goods.
r1
r0
1
DLF
DLF
Loanable Funds
LF0
LF1