Chapter 2 Flashcards
Loanable Funds Theory
Suggests that the market interest rate is determined by the factors that control supply of and demand for loanable funds.
Explains movements in the general level of interest rates.
Explains why interest rates among debt securities vary.
Household Demand for Loanable Funds
To finance housing expenditures as well as the purchase of automobiles and household items.
Inverse relationship between the interest rate and the quantity of loanable funds demanded.
Business Demand for Loanable Funds
Will demand a greater quantity of loanable funds at a given point in time if interest rates are lower.
Government Demand for Loanable Funds
Demand loanable funds when planned expenditures are not covered by incoming revenues.
Is said to be interest inelastic (insensitive to interest rates).
Expenditures and tax policies are independent of the level of interest rates.
Foreign Demand for Loanable Funds
Depends on the interest rate differential between the two countries.
The greater the differential, the greater the demand for foreign funds.
The quantity of loanable funds demanded by foreign governments will be inversely related to the home country’s interest rates.
Supply of Loanable Funds
Households are the largest suppliers.
More supply at higher interest rates.
By affecting the supply of loanable funds, the Fed’s monetary policy affects interest rates.
Aggregate Demand for Funds (Da)
Da = Dh + Db + Dg + Dm + Df
Dh = household demand
Db = business demand
Dg = federal government demand
Dm = municipal government demand
Df = foreign demand
Aggregate Supply for Funds (Sa)
Sa = Sh + Sb + Sg + Sm + Sf
Sh = household supply
Sb = business supply
Sg = federal government supply
Sm = municipal government supply
Sf = foreign supply
Equilibrium Interest Rate
At equilibrium interest rate i, the supply of loanable funds is equal to the demand for loanable funds.
At interest rates above i, there is a surplus of loanable funds.
At interest rates below i, there is a shortage of loanable funds.
Economic Growth on Interest Rates
Puts upward pressure on interest rates by shifting demand for loanable funds outwards.
Inflation on Interest Rates
Puts upward pressure on interest rates by shifting supply of funds inwards and demand for funds outward.
Fisher Effect
i = E(INF) + iR
i = nominal or quoted rate of interest
E(INF) = expected inflation rate
iR = real interest rate
Monetary Policy on Interest Rates
When the Fed reduces (increases) the money supply, it reduces (increases) the supply of loanable funds, putting upward (downward) pressure on interest rates.
Crowding-Out Effect
Given a certain amount of loanable funds supplied to the market, excessive government demand for funds tends to “crowd out” the private demand for funds.
Foreign Flows of Funds on Interest Rates
Interest rates for a certain currency are determined by the demand for funds in that currency and the supply of funds available.
Net Demand (ND)
ND = Da - Sa
ND = (Dh+Db+Dm+Df) - (Sh+Sb+Sm+Sf)
Future Demand for Loanable Funds
Depends on future foreign demand for home funds, household demand, business demand, and government demand.
Future Supply of Loanable Funds
Depends on future supply by households and others, and foreign supply of loanable funds in home country.
