CHAPTER 2. Determination of Interest Rates. CHAPTER 2 OVERVIEW. This chapter will: A. Apply loanable funds theory to explain why interest rates change B. Identify the most relevant factors that affect interest rate movements C. Explain how to forecast interest rates.
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Determination of Interest Rates
This chapter will:
A. Apply loanable funds theory to explain why interest rates change
B. Identify the most relevant factors that affect interest rate movements
C. Explain how to forecast interest rates
There exists an inverse relationship between the interest rate and the quantity of loanable funds demanded.
2. Business Demand
businesses will demand a greater quantity of loanable funds at lower interest rates
3. Government Demand
expenditures and tax policies
independent of the level of interest rates or interest-inelastic
4. Foreign Demand for Loanable Funds
5. Determinants of the Supply of Loanable Funds
a. suppliers more willing to supply at higher rates
b. U.S. supply is influenced by the Federal Reserve
c. Tax rates on interest income affect the level of supply
6. Equilibrium Interest Rates
a. In equilibrium:
DA = the aggregate demand for loanable funds
SA = the aggregate supply for loanable funds
a. Slowdown in growth:
b. Increase in growth:
2. Impact of Inflation on Interest Rates
a. Fisher Effect:
states that the real rate of interest is the nominal rate less the expected inflation rate.
b. The greater the expected rate of inflation, the greater the nominal rate of interest.
3. Impact of the Budget Deficit on Interest Rates
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.
4. Impact of Foreign Flows of Funds on Interest Rates
In recent years, massive flows of funds have shifted between countries causing abrupt shifts in the supply of loanable funds.
a. Foreign demand for U.S. funds
b. Household demand for funds
c. Business demand for funds
d. Government demand for funds
a. Future supply by households and others
b. Future foreign supply of loanable funds in the U.S.