Module 29
The Market
for Loanable Funds
KRUGMAN'S
MACROECONOMICS for AP*
Margaret Ray and David Anderson
What you will learn
in this Module:
• How the loanable funds market matches
savers and investors
• The determinants of supply and demand
in the loanable funds market
• How the two models of interest rates can
be reconciled
The Market for Loanable Funds
•The Equilibrium Interest Rate
•Loanable Funds Market
•Nominal v. Real Interest Rate
•Rate of Return
•The laws of supply and demand explain the
behavior of savers and borrowers
The Market for Loanable Funds
•Remember –
I = Private Savings + Public Savings + Capital
Inflow
•Savers supply the S (lenders)
•Investors demand the D (borrowers)
•Loanable Fund Model used to determine the Equilibrium
Real Interest Rate
•The laws of supply and demand explain the behavior of
savers and borrowers
•Real Interest Rate (r) = nominal
interest rate – expected inflation
Equilibrium in the Loanable
Funds Market
Real Interest Rate (r) =
nominal interest rate –
expected inflation
Funded projects
Lend offers NOT accepted
Unfunded projects
Lend offers accepted
Shifts of the Demand for
Loanable Funds
• ∆ Perceived Business
Opportunities
• Growing economy =
right shift
• Recession = left shift
Shifts of the Demand for
Loanable Funds
• ∆ Government
Borrowing
• Budget deficit = more
borrowing = right shift
• Budget surplus = less
debt so less
borrowing = left shift
Shifts of the Demand for
Loanable Funds
• Crowding Out
Higher Interest rates will
cause some investment to
be ‘crowded out’ by the
government’s demand for
loadable funds.
Shifts of the Supply of Loanable
Funds
• ∆ Private Savings
Behavior
• Consume more = save
less = left shift
Shifts of the Supply of Loanable
Funds
• ∆ Capital Inflows
• A nation is perceived to
have a stable
government, strong
economy, a good place to
save money.
• Foreign $$$ will flow into
nation’s financial market,
increasing the S of
loadable funds.
Inflation and Interest Rates
•Anything that shifts either the S or D for loanable
funds changes the interest rate.
•Borrowers – true cost of borrowing is the real
interest rate
•Lenders – true payoff of lending is the real interest
rate
Inflation and Interest Rates
•The Fisher Effect
• As long as the Level of Inflation is Expected
• NO affect on
• Equilibrium Q of loanable funds
• Expected real interest rate
• Yes affect on nominal interest rate
This
Inflation and Interest Rates
This graph shows
that the only thing
rising is the
Nominal
Interest Rate.
Equilibrium Q
Is the same.
D and S for
Loanable funds
Will be at Equilibrium
At the higher
Nominal interest rate.
Reconciling the Two Interest Rate
Models:
The Interest Rate in the Short Run
Reconciling the Two Interest Rate Models:
The Interest Rate in the Long Run
Graph Practice
Use a correctly labeled graph to show how the market for loanable
funds is affected. Show in your graph the impact on the equilibrium
interest rate and Q of loanable funds.
1. The chair of the Federal Reserve testifies before Congress that
he/she expects the health of the economy to significantly improve
in the coming months.
2. Households fear an imminent recession and begin to cut bank on
discretionary purchases.
3. The Federal government announces another annual budget
surplus.
4. The flow of foreign financial capital into American financial
markets begins to decrease.