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