Loanable Funds market Framework

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# Loanable Funds market Framework - PowerPoint PPT Presentation

Loanable Funds market Framework. This framework is particularly useful for predicting interest rate. changes due to events in the country or the world .

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Presentation Transcript
Loanable Funds market Framework
• This framework is particularly useful for predicting interest rate

changes due to events in the country or the world .

The analysis is conducted in terms of the price of money– interest rates– directly. No extra step is needed to relate the price of bonds (inversely) to the interest rate.

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Step 2: What is the PRICE of the thing?

Step 3: Who DEMANDS it? borrowers

LIST all the factors that affect demand:expected income,expected inflation, gov’t deficit...

interest rate

they’d want less

Step 4: From this initial i&Q, if the interest rate increased, would borrowers want more or less?...

Draw and label the axis

Note that DLFby borrowers = SB

label it

5. DLFby borrowers

Step 5: connect those two points with the DEMAND curve

QLF

Step 1: What is the thing?loanable funds

Draw and LABEL the axis

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Step 6: Who supplies it? savers

List factors that affect supply:wealth, relative expected returns, relative risk, relative liquidity, expected inflation...

i

LABEL IT:

Step 8. SLF by savers

they’d save more

Note that SLF by savers = DBONDS

Step 8:draw the supply curve

Step 7:from an initial i,Q; if i increased, would savers provide less, or more...?

DLFby borrowers (=SBONDS)

QLF

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i

SLF by savers

io

Step 9:identify the initial equilibrium interest rate (and quantity)

DLFby borrowers

QLF

Qo

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Example Event:

What will happen to interest rates if people expect inflation to rise?

DLF = f ( i; eGDP, gov’t deficit, e) = SBONDS

DEMAND:if borrowers expect inflation to rise (later), they would rather buy more stuff now (to expand capacity, or whatever) so they would BORROW MORE NOW. DLF increases (= SBONDS increases).

SLF = f ( i; W, eRETB/eREToth, B/oth, lB/loth, e) = DBONDS

SUPPLY: if savers expect inflation to rise (later), they would rather buy more stuff now, so they would SAVE LESS NOW. SLF decreases (=DBONDS decreases).

Now illustrate these effects on your graph,

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Step 12.illustrate change (if any) inSupply

i

SLF by savers

i1

SLF decreases

io

DLF increases

DLFby borrowers

Step 11.illustrate change (if any) inDemand

Step 13.identify the new equilibrium i

QLF

Qo

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Step 14.SUMMARIZE: If people expect inflation to rise, savers will supply fewer loans, because they would rather buy stuff now while prices are low. Borrowers will demand more loans so they can expand capacity and sell more stuff later when prices are higher. Interest rates will rise.

i

SLF by savers

i1

io

DLFby borrowers

QLF

note: the change in the equilibrium quantity of loanable funds is not important in the analysis of interest rates.

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