Unit 8. Determination of Interest Rates Movements. The loanable funds theory, is commonly used to explain interest rate movements, suggests that the market interest rate is determined by the factors that control the supply of and demand for loanable funds.
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interest rate movements, suggests that the market interest rate is determined by the factors that control the supply of and demand for loanable funds.
(a)household demand for loanable funds;
(b) corporate demand for loanable funds;
(c) government demand for loanable funds;
(d) foreign demand for loanable funds.
For instance, the British government may obtain financing by issuing British treasury securities to U.S. investors, representing a British demand for U.S. funds. British demand for U.S. funds is influenced by the differential between its interest rates and U.S. rates.
Therefore, for a given set of foreign interest rates, the quantity of domestic loanable funds demanded by foreign governments or firms will be inversely related to domestic interest rate.
Based on the above analysis, because most of these sectors are likely to demand a larger quantity of funds at lower interest rates, the aggregate demand for loanable funds is inversely related to interest rates at any point
financial markets by savers.
(a) The household sector is the largest supplier;
(b) The loanable funds are supplied by some
government units that temporarily generate
more tax revenues than they spend;
(c) The loanable funds are supplied by some
businesses whose cash inflows exceed
Households as a group represent a net supplier of loanable funds, whereas governments and businesses are net
demanders of loanable funds.
(a) If the aggregate demand for loanable funds increases without a corresponding increase in aggregate supply, there will be a shortage of loanable funds. Interest rates will rise until an additional supply of loanable funds is available to meet the excess demand.
(b) If the aggregate supply of loanable funds increases without a corresponding increase in aggregate demand, there will be a surplus of loanable funds. Interest rates will fall until the quantity of funds supplied no longer exceeds the quantity of funds demanded.