All Flashcards
What is the nominal interest rate?
The stated interest rate before accounting for inflation.
What is the real interest rate?
The interest rate after adjusting for inflation; reflects the true return on investment or cost of borrowing.
Define inflation premium.
Compensation lenders require for the expected loss of purchasing power of money over time, included in the nominal interest rate.
What is the market for loanable funds?
The market where savers (suppliers of funds) and borrowers (demanders of funds) interact to determine the interest rate.
What is the formula for nominal interest rate?
Nominal Interest Rate = Real Interest Rate + Inflation
What is the formula for real interest rate?
Real Interest Rate = Nominal Interest Rate - Inflation
What is the significance of a negative real interest rate?
Inflation is higher than the nominal interest rate, eroding savings value and making borrowing cheaper.
Define expected inflation rate.
The rate of inflation that economists and lenders anticipate will occur in the future, used to set nominal interest rates.
What determines the equilibrium interest rate?
The interaction of supply and demand in the market for loanable funds, factoring in expected inflation.
What is the relationship between nominal and real interest rates?
The nominal interest rate includes the effect of inflation, while the real interest rate shows the true return after accounting for inflation.
How does expansionary monetary policy affect nominal interest rates?
It typically lowers nominal interest rates to stimulate borrowing and investment.
How does contractionary monetary policy affect nominal interest rates?
It typically raises nominal interest rates to reduce inflation.
What is the effect of increased government spending on real interest rates?
Increased government spending can increase demand for loanable funds, potentially raising real interest rates.
How do tax incentives for savings affect the supply of loanable funds?
They increase the supply of loanable funds, potentially lowering real interest rates.
What is the impact of a government budget surplus on the market for loanable funds?
It increases the supply of loanable funds, potentially lowering real interest rates.
How does fiscal policy influence the demand for loanable funds?
Government borrowing to finance deficits increases demand; tax policies affecting investment can also shift demand.
What is the effect of quantitative easing on interest rates?
Quantitative easing typically lowers interest rates by increasing the money supply and purchasing government bonds.
How does the central bank influence nominal interest rates?
Through tools like the federal funds rate and the discount rate, influencing the cost of borrowing for banks.
What is the impact of inflation targeting on nominal interest rates?
Central banks adjust nominal interest rates to maintain the target inflation rate.
How do international capital flows affect domestic interest rates?
Inflows increase the supply of loanable funds, potentially lowering rates; outflows decrease supply, potentially raising rates.
On a loanable funds market graph, show the effect of increased government borrowing.
The demand curve shifts right, increasing both the equilibrium interest rate and quantity of loanable funds.
On a loanable funds market graph, show the effect of increased consumer savings.
The supply curve shifts right, decreasing the equilibrium interest rate and increasing the quantity of loanable funds.
How does increased business investment affect the loanable funds market?
It shifts the demand curve for loanable funds to the right, increasing the equilibrium interest rate and quantity of loanable funds.
Illustrate the impact of decreased consumer confidence on the loanable funds market.
The demand curve shifts left, decreasing both the equilibrium interest rate and quantity of loanable funds.
How would a decrease in the supply of loanable funds affect the equilibrium?
The supply curve shifts left, increasing the equilibrium interest rate and decreasing the quantity of loanable funds.
What does the vertical axis represent in the market for loanable funds?
The real interest rate.
What does the horizontal axis represent in the market for loanable funds?
The quantity of loanable funds.
Explain how expected inflation is reflected in the loanable funds market.
Expected inflation influences both the supply and demand curves, affecting the equilibrium nominal interest rate.
Show the effect of a tax cut on savings on the loanable funds market graph.
The supply curve shifts right, leading to a lower equilibrium interest rate and a higher quantity of loanable funds.
How does a change in the risk associated with lending affect the supply of loanable funds?
Increased risk reduces the supply, shifting the supply curve left and increasing the equilibrium interest rate.