Chapter 22 Savings, Interest, Rates, and the Market for Loanable Funds

fisher equation

Relates inflation to the real and nominal interest rate real interest rate= nominal interest rate-inflation rate nominal interest rate= real interest rate+inflation rate

notes about borrowing

every dollar borrowed requires a dollar saved lenders can't lend money they don't have savings provides funds for lenders to lend

when should a firm borrow?

expected return on investment > interest rate on loan cost benefit analysis

demander

firm

investment

firm buys capital, use investment to make something

investor confidence

firm is optimistic it will borrow more today

how do you define the market like any other market?

good: loanable funds price: interest rate sellers (suppliers): savers buyers (demanders): borrowers

supplier

households

quantity

how much of the product called a loan is available

Loanable funds market

includes such places as -stock exchanges -investment banks -mutual fund firms -commercial banks borrowers use funds for business savers lend to businesses

productivity of capital

more productive the demand for loans increases the returns to investment (interest rate) will be greater

the quantity of loanable funds demanded is..

negatively related to the interest rate

consumption smoothing

- No large changes in consumption with changes in income - Income changes over the course of the typical lifetime

stock

partial owner

time preferences

people generally prefer goods sooner rather than later and funds are no different high time preferences means want goods now low time preferences mean more saving not uniform less patient save less

the quantity of loanable funds supplies is...

positively related to the interest rate

Loanable fund market order

savers->savings->loanable funds market-> loans->borrowers

chain of borrowing

savings --> borrowing --> investment --> GDP loanable funds market makes this process efficient

loanable funds market in equilibrium

savings=investment every dollar borrowed requires a dollar saved

decline in investor confidence

tends to decline when economy slows firms expect reduced sales and investors expect lower return on their investments this will result in a lower level of investment and a lower interest rate

interest rate on the demand side

the cost of borrowing

nominal interest rate

the interest rate before it is corrected for inflation

real interest rate

the interest rate corrected for the effects of inflation

what sets the interest rate?

the market interest rate goes up, more demand or less supply

interest rate

the price of loanable funds -savers: the reward for saving -borrowers: the cost of borrowing like other prices it rises and falls affected by supply and demand

what happens when you save money?

you are supplying funds the price you receive in return is the interest -percentage rather than dollars

economy gets bad

demand shift left supply shift right bc saving more

graph of consumption smoothing

early life (borrow) prime earning years (save) later life (dissaving)

shift in the supply of loanable funds is caused by

Changes in income and wealth Changes in time preferences Consumption smoothing

demand of loanable funds

Comes from people wanting to borrow money Interest rate is the cost of borrowing

bond

IOU, have to pay you back

changes in income and wealth

Increases in income generally increase savings shift to the right

loanable funds law of supply

The quantity of savings rises when the interest rate increases

retirement of baby boomers causes

another reason to believe in leftward shift of supply result could be less investment and reduced GDP

do you save more in a good or bad economy

bad economy

what does it mean when the real interest rate is negative

bank is paying you to take a loan pay back less than you borrowed

with out loans there would

be no businesses

demanders of loanable funds

borrowers need to borrow for large capital purchases governments borrow too

movement along the demand curve

caused by a change in the interest rate (price)

movement along the supply curve for loanable funds

caused by a change in the interest rate (price)

Fall in the savings rate over past 30 years is due to

change in time preferences left supply shift in loanable funds market foreign savings in US market could shift supply back to the right

shift in the demand of loanable funds

changes in the productivity of capital changes in investor confidence

supply of loanable funds

comes from people saving money, interest rate is a reward for saving