Loanable Funds Theory - 5819 Words

JOURNAL OF ECONOMICS AND FINANCE EDUCATION †¢ Volume 6 †¢ Number 1 †¢ Summer 2007 48 Reconsidering the Introduction to Interest Rate Theory S. Kirk Elwood1 ABSTRACT The various theories of interest rate determination presented in economics textbooks each spotlight a particular fundamental force behind the equilibrium rate. Unfortunately, each theory’s successful emphasis of one determinant of the interest rate comes at the cost of distorting some other aspect of its determination. This paper argues that the basic market analysis of debt securities (e.g., bonds and commercial paper) left out of most macroeconomic as well as money and banking textbooks provides a straightforward and practical perspective on interest rate determination†¦show more content†¦But they never extend the analysis to show how interest rates are generally determined by debt securities markets. Most intermediate texts similarly discuss the inverse relationship between interest rates and bond prices without mentioning the markets where those prices are determined (e.g., Blanchard 2003, and DeLong and Olney 2006). Able and Bernanke (2005) go a little further by acknowledging that changes in money demand affect bond holdings, but still no debt securities market is developed. JOURNAL OF ECONOMICS AND FINANCE EDUCATION †¢ Volume 6 †¢ Number 1 †¢ Summer 2007 49 This distinction between debt securities prices and interest rates – on which more will be said below – is supported by the fact that the actual markets where their joint values are determined are explicitly debt securities markets. Bond markets – primary as well as secondary – and commercial paper markets quote either the prices or discount rates of their debt securities, and leave the corresponding interest rate to be inferred. The â€Å"interest rate† is a pricing term generally spoken outside of the larger financial markets by retail borrowers and lenders such as local banks.3 In addition to the great familiarity with interest rates by those who borrow or lend through banks, most economists dependably refer to interest rates instead of debt securities’ prices because it is assumed that economic agents think in terms of interestShow MoreRelated2.2 Theoretical Literature. 2.2.1 Theoretical Literature1075 Words   |  5 Pages Classical Theory of Interest rate This theory was developed by economists like Prof. Pigou, Prof. Marshall, Walras, Knight etc. According to this theory, Interest is the reward for the productive use of the capital which is equal to the marginal productivity of physical capital. The classical theorists regarded interest rate as an equilibrating factor between the demand for and the supply of investible funds. Investment represents the demand for investible funds, and interestRead MoreEconomics Notes: Small and Open Economies, Growth, Aggregate Supply and Demand926 Words   |  4 Pagesborrowing more expensive, the quantity of loanable funds demanded falls as the interest rate rises. The supply and demand for loanable funds depend on the real interest rate and not nominal. Increase in saving = shift the supply of loanable funds to the right = reduces the interest rate. (graphique page 181) Increase in investment = demand for loanable funds increase = interest rise. Incentive to increase investment = increase in quantity of loanable funds demanded When the government has a budgetRead MoreCarl Menger s Principles Of Economics1344 Words   |  6 Pagesconsumable output. The economy is at full employment and it is using all of its resources when it is along the curve. The bottom graph is the loanable funds market. On the x-axis there is quantity of loanable funds and on the y-axis is interest rate. Austrians believe that the money that is not spent on consumable goods is then saved and turned into loanable funds. Similar to the MPC, there is always a percentage of money that the consumer does not spend. If a person deposits their savings into aRead MoreTheu.s Gross Domestic Product ( Gdp )1695 Words   |  7 Pagesfor jobs since they will be willing to accept low wages. So even if easier monetary policy is adopts inflation will not rise. According to the classical economists, there is no effect of monetary policies on the real variables. The provided quantity theory of money: MV=PY If there is an increase in money supply this will shift the LM curve to the down and this will lower the rate of interest. With lower interest rate there is a higher investment and this will shift the AD curve to the right and increasesRead MoreWhat Are The Three Reasons The Aggregate Demand Curve Slopes Downward?960 Words   |  4 Pagesthey can then place in financial intermediaries (banks) who can in turn loan those funds out. An increase in the supply of loanable funds decreases the interest rate for borrowing funds, enticing people/businesses to borrow funds for investment purposes, increasing the demand for goods and services. If the price level increases, consumers will have less money to place in banks, depleting the supply of loanable funds, which will increase the interest rate deterring individuals from borrowing. ThisRead MoreFiscal Policy And Fiscal Policies1193 Words   |  5 Pagesfiscal policy can be used to raise income, stimulate spending and increase levels of pr oduction in a given economy, be it open or closed. Gradually, as unemployment falls, this sequence allows the economy to move towards full employment. As with most theories, expansionary fiscal policy does indeed have its criticisms and downfalls. If a given household’s expenditure were to be higher than the household’s income, it would spell financial trouble unless the extra spending can be funded somehow. SimilarlyRead MoreEcon 1103- Practice Midterm Exam2153 Words   |  9 Pagescomparative advantage in both beef and wine c) Canada has an absolute advantage in beef and a comparative advantage in wine d) Argentina has an absolute advantage in wine and a comparative advantage in beef 6. According to the data in Table 1 and the theory of comparative advantage: a) Canada should export both goods and Argentina should export neither good b) Argentina should export both goods and Canada should export neither good c) Canada should export beef and Argentina should export wine d)Read MoreHigh Saving Promotes Faster Growth2505 Words   |  11 Pagesby 5% from 2007, positive growth was still seen. This suggests China coped better during the economic recession and thereby could suggest is less susceptible to downturn in the future, helping to ensure the long run prosperity of the economy. The theory behind this is that during uncertain times, households with savings to fall back on are less likely to reduce consumption immediately. Hence, aggregate demand should not fall as profoundly as households can still purchase the same level of goods andRead MoreOptimism in the Long Run2012 Words   |  9 Pagespolicies the Fed is using to stimulate economic growth are: 1. Very low interest rates (Federal funds rate and discount rate) 2. Quantitative Easing Program: Spending $65B (down from $75B) a month on the purchase of U.S. Government bonds from banks Quantitative easing increases the banks supply of loanable funds. Additionally, the Fed controls the interest rates for banks to loan money to one another (Federal Funds rate) and to borrow directly from the Fed (Discount rate). Banks take loans from other banksRead MoreA New Production Facility At Chine For Apple Essay2072 Words   |  9 Pageswas 22% of GDP, but the growth in spending was decreased. In the 1990 s, the U.S. experienced increased growth due to the introduction of new technology in production to speed up the output of products. This new technology afforded companies the funds to hire more employs and increase profit. This consumer demand leads to stock prices going through the roof, leading to the inevitable bubble bursting and stock prices plunging in 2000. This was the beginning of the recession that hit the U.S. hard