Glossary
Borrowers
Individuals, firms, or governments who seek to obtain funds for investment or consumption, representing the demand side of the loanable funds market.
Example:
A startup company seeking capital to expand its operations is a borrower in the market.
Deficit Spending
When a government spends more money than it collects in revenue, requiring it to borrow funds, which increases the demand for loanable funds.
Example:
Large-scale government infrastructure projects funded by borrowing would lead to increased deficit spending, shifting the demand for loanable funds to the right.
Demand for Loanable Funds
The total amount of funds that borrowers are willing and able to borrow at various real interest rates, typically showing an inverse relationship with the rate.
Example:
A surge in business confidence leading to more investment projects would increase the demand for loanable funds.
Direct Relationship (Supply)
The principle that as the real interest rate increases, the quantity of loanable funds supplied increases, and vice versa.
Example:
A higher interest rate on savings accounts incentivizes people to save more, demonstrating the direct relationship between interest rates and the quantity of funds supplied.
Discount Rate
The interest rate at which commercial banks can borrow money directly from the Federal Reserve.
Example:
A decrease in the discount rate makes it cheaper for banks to borrow, potentially increasing the money supply and the supply of loanable funds.
Equilibrium (Loanable Funds Market)
The point in the loanable funds market where the quantity of funds demanded by borrowers exactly equals the quantity of funds supplied by savers.
Example:
At the equilibrium real interest rate, the amount of money people want to save perfectly matches the amount businesses want to invest.
Expectations for the Future (Demand Shifter)
Borrowers' optimism or pessimism about future economic conditions, which influences their willingness to invest and thus their demand for loanable funds.
Example:
If businesses anticipate a strong economic recovery, their positive expectations for the future will likely increase their demand for investment loans.
Expectations for the Future (Supply Shifter - Economic Contraction)
When individuals anticipate an economic downturn, they tend to increase their precautionary savings, thereby increasing the supply of loanable funds.
Example:
Fears of job losses during a recession often lead to an increase in the supply of loanable funds as people save more for emergencies.
Expectations for the Future (Supply Shifter - High Inflation)
When savers anticipate high future inflation, they are less willing to lend at current nominal interest rates because the real return on their savings will be eroded, decreasing the supply of loanable funds.
Example:
If people expect high inflation to erode the value of their money, they might be less inclined to save, causing the supply of loanable funds to decrease.
Foreign Demand for Domestic Investment
When foreigners want to invest in a country's economy, they demand that country's currency to purchase assets, which can increase the demand for loanable funds.
Example:
If global investors view the U.S. as a safe haven, their foreign demand for domestic investment in U.S. bonds could increase the demand for loanable funds.
Foreign Purchases of Domestic Assets
When foreign investors buy financial or real assets in a country, which provides funds to that country's loanable funds market, increasing supply.
Example:
An increase in global demand for U.S. Treasury bonds would represent increased foreign purchases of domestic assets, boosting the supply of loanable funds in the U.S.
Increased Borrowing/Credit Demand
A general increase in the desire or need for loans and credit by individuals and businesses, which shifts the demand for loanable funds.
Example:
A booming economy often leads to increased borrowing/credit demand as businesses seek to expand and consumers make larger purchases.
Inverse Relationship (Demand)
The principle that as the real interest rate increases, the quantity of loanable funds demanded decreases, and vice versa.
Example:
When mortgage rates rise, fewer people are willing to take out home loans, illustrating the inverse relationship between interest rates and the quantity of funds demanded.
Lending at the Discount Window
The process by which commercial banks borrow money directly from the Federal Reserve, affecting the overall supply of reserves and thus the supply of loanable funds.
Example:
If the Federal Reserve lowers the discount rate, it encourages banks to engage in more lending at the discount window, increasing the supply of loanable funds in the economy.
Loanable Funds Market
A conceptual market where the supply of funds from savers meets the demand for funds from borrowers, determining the real interest rate.
Example:
When a government issues bonds to finance its debt, it is participating in the loanable funds market as a borrower.
Nominal Interest Rate
The stated interest rate on a loan or investment, not adjusted for inflation.
Example:
If a bank offers a savings account with a 2% annual return, that is the nominal interest rate.
Real Interest Rate
The price of borrowing money, adjusted for inflation, which balances the quantity of loanable funds demanded and supplied.
Example:
If the nominal interest rate on a loan is 7% and the inflation rate is 4%, the real interest rate is 3%, reflecting the true cost of borrowing.
Savers
Individuals or entities who choose to defer current consumption and make their funds available for lending, representing the supply side of the loanable funds market.
Example:
When you deposit money into a certificate of deposit (CD), you are acting as a saver, contributing to the supply of loanable funds.
Savings Rate
The proportion of disposable income that households and individuals choose to save rather than consume, directly influencing the supply of loanable funds.
Example:
A cultural shift towards increased personal financial planning could boost the national savings rate, increasing the supply of loanable funds.
Supply of Loanable Funds
The total amount of funds that savers are willing and able to lend at various real interest rates, typically showing a direct relationship with the rate.
Example:
If households decide to save a larger portion of their income, the supply of loanable funds will increase.