Ch. 2 Determination of interest Rate Flashcards
The Loanable Funds Theory
market interest rates are determined by the factors that control the supply/demand for loanable funds.
why do Household Demand Loanable Funds?
-to finance housing expenditures, purchases of automobiles, and household items.
-higher interest rate = decrease in demand for loanable funds VS lower interest rate = increase in demand for loanable funds
when does Business Demand a greater quantity of Loanable Funds?
when the interest rates are lower
why does the Government Demand Loanable Funds?
-when planned expenditures are not covered by incoming revenues.
-Government demands are interest inelastic (insensitive to interest rates)
-Expenditures/tax policies are independent of interest rates.
What’s the difference between municipal and t-bonds?
municipal
-sensitive to rates
-City raise the municipal bond
-no taxes = lower return
T-Bond
-inelastic
what’s the difference between monetary and fiscal policies?
monetary is when the Fed controls the interest rate
-to achieve price stability, full employment, and stable economic growth
fiscal is the tax and spending policies of the federal government
-influence politic and how money work
Slide # 9 will add question later
1
explain Foreign Demand for Loanable Funds.
demand for foreign funds depends on the interest rate differential between the two countries
-EX: Foreign demand for U.S. loanable funds depends on U.S. interest rate
-greater the differential = greater demand for foreign funds
who is the largest supplier of Loanable Funds?
households, but some are supplied by gov units
-higher interest rate = more supply of Loanable Funds VS lower interest rate = less supply of Loanable Funds
-they Supply by buying securities (like iBonds and T-bills).
What can the Fed do to increase or decrease the money supply?
to increase the money supply, the Fed will purchase bonds, which injects money into the banking system VS To decrease the money supply, the Fed will sell bonds, which remove capital from the banking system.
How can you tell if there’s a surplus or shortage of loanable funds?
if the interest rate is above equilibrium, there is a surplus of loanable funds VS if the interest rate is below equilibrium, there is a shortage of loanable funds.
what’s the Impact of economic growth on interest rates?
-upward pressure on interest rates by shifting demand for loanable funds outward
-Good times = more expected cash flow = demand more funds and no change to supply
what’s the Impact of inflation on interest rates?
Puts upward pressure on interest rates by shifting supply of funds inward and demand for funds outward
-spend our money now!
demand goes up
-let’s borrow now while things are still cheap
what’s the Impact of Monetary Policy on Interest Rates?
When the Fed increases the money supply = increases in the supply of loanable funds = downward pressure on interest rates.
When the Fed reduces the money supply = decreases in the supply of loanable funds = upward pressure on interest rates.
what’s the Fed going to do during a weak economy?
stimulate the economy by decreasing rates = increase in demand for borrowing/spending if rates are low. = increase the supply of loanable funds.
Lots of money supply = low-interest rates.
