Glossary
Demand for Loanable Funds
The total amount of money that households, businesses, and the government are willing to borrow for investment and consumption at various real interest rates.
Example:
A booming economy with many profitable investment opportunities would increase the demand for loanable funds as businesses seek to expand.
Expected Inflation
The rate of inflation that economic agents, such as consumers, businesses, and lenders, anticipate will occur in the future.
Example:
When banks set interest rates on long-term loans, they factor in their expected inflation over the loan's duration to ensure a positive real return.
Inflation
A general increase in the prices of goods and services in an economy over a period of time, leading to a decrease in the purchasing power of money.
Example:
If a basket of groceries cost 103 this year, the economy experienced 3% inflation.
Market for Loanable Funds
A hypothetical market where savers supply funds and borrowers demand funds, determining the equilibrium real interest rate.
Example:
An increase in government borrowing would increase the demand for funds in the market for loanable funds, potentially raising interest rates.
Money Market
A market for short-term borrowing and lending, typically involving highly liquid assets with maturities of less than one year.
Example:
When the Federal Reserve conducts open market operations, it primarily influences interest rates in the money market by affecting the supply of reserves.
Nominal GDP
The total value of all final goods and services produced within a country's borders in a given period, measured using current market prices.
Example:
If a country's economy produced $20 trillion worth of goods and services in 2023, that figure represents its nominal GDP for that year.
Nominal Interest Rate
The stated interest rate on a loan or investment before accounting for inflation. It is the headline rate advertised by financial institutions.
Example:
If you take out a car loan at 6% interest, that 6% is the nominal interest rate you'll pay on the principal.
Real GDP
The total value of all final goods and services produced within a country's borders in a given period, adjusted for inflation to reflect changes in output only.
Example:
Economists use real GDP to compare economic output between different years, ensuring that growth is due to increased production rather than just rising prices.
Real Interest Rate
The interest rate adjusted for inflation, reflecting the true return on an investment or the actual cost of borrowing in terms of purchasing power.
Example:
If your savings account offers a 2% nominal interest rate but inflation is 3%, your real interest rate is -1%, meaning your purchasing power is decreasing.
Supply of Loanable Funds
The total amount of money that households, businesses, and the government are willing to save and lend at various real interest rates.
Example:
If people decide to save more of their income, the supply of loanable funds will increase, potentially lowering interest rates.