The Loanable Funds theory We use the term “loanable funds market” to describe the arrangements...
description
Transcript of The Loanable Funds theory We use the term “loanable funds market” to describe the arrangements...
![Page 1: The Loanable Funds theory We use the term “loanable funds market” to describe the arrangements and institutions by which saving of households is made available.](https://reader035.fdocuments.us/reader035/viewer/2022062504/5a4d1b647f8b9ab0599af400/html5/thumbnails/1.jpg)
The Loanable Funds theoryWe use the term “loanable
funds market” to describe the arrangements and institutions
by which saving of households is made available to borrowers.
![Page 2: The Loanable Funds theory We use the term “loanable funds market” to describe the arrangements and institutions by which saving of households is made available.](https://reader035.fdocuments.us/reader035/viewer/2022062504/5a4d1b647f8b9ab0599af400/html5/thumbnails/2.jpg)
Factor income
Consu
mption
1. Leakages must be recycled if total spending is to match full-employment GDP.
2. According to the Classical theory, the loanable funds market acts as a conduit to transfer spending power (S) from households to borrowing units (firms and government units).
3. Saving (S) is the “source” of loanable funds.
Saving
Net taxes
![Page 3: The Loanable Funds theory We use the term “loanable funds market” to describe the arrangements and institutions by which saving of households is made available.](https://reader035.fdocuments.us/reader035/viewer/2022062504/5a4d1b647f8b9ab0599af400/html5/thumbnails/3.jpg)
1. To have a more secure future, to start a business, to finance a child’s education, to satisfy miserliness, . . .
2. To earn interest. We view interest as
the “reward for saving” or the “reward for postponing
gratification.”
![Page 4: The Loanable Funds theory We use the term “loanable funds market” to describe the arrangements and institutions by which saving of households is made available.](https://reader035.fdocuments.us/reader035/viewer/2022062504/5a4d1b647f8b9ab0599af400/html5/thumbnails/4.jpg)
Interest rate Future value4% $1,127.275% $1,161.476% $1,196.687% $1,232.938% $1,270.249% $1,308.6510% $1,348.1811% $1,388.8812% $1,430.77
Value of $1,000 in 3 years at alternative interest rates
The opportunity cost of spending
now (measured in lost future
spending) is positively related to
the interest rate.
![Page 5: The Loanable Funds theory We use the term “loanable funds market” to describe the arrangements and institutions by which saving of households is made available.](https://reader035.fdocuments.us/reader035/viewer/2022062504/5a4d1b647f8b9ab0599af400/html5/thumbnails/5.jpg)
Saving = Supply of Funds
Trillions of Dollars
0
Inte
rest
rat
e
3%
5%
1.5 1.75
Supply of Funds
![Page 6: The Loanable Funds theory We use the term “loanable funds market” to describe the arrangements and institutions by which saving of households is made available.](https://reader035.fdocuments.us/reader035/viewer/2022062504/5a4d1b647f8b9ab0599af400/html5/thumbnails/6.jpg)
•To finance the acquisition of long-lived capital goods.
•The rate of interest is the cost of borrowing or the price of loanable funds.
•The investment demand curve indicates the level of investment spending at various interest rates.
•As the interest rate decreases, more investment projects become attractive in the assessment of business decision-makers—hence, the investment demand function is downward-sloping with respect to the interest rate.
![Page 7: The Loanable Funds theory We use the term “loanable funds market” to describe the arrangements and institutions by which saving of households is made available.](https://reader035.fdocuments.us/reader035/viewer/2022062504/5a4d1b647f8b9ab0599af400/html5/thumbnails/7.jpg)
Investment Demand
Trillions of Dollars
0
Inte
rest
rat
e
3%
5%
1.5
Demand for Funds by Business
1.0
A
B
When the interest rate falls, investment spending and the business borrowing needed to finance it rises.
![Page 8: The Loanable Funds theory We use the term “loanable funds market” to describe the arrangements and institutions by which saving of households is made available.](https://reader035.fdocuments.us/reader035/viewer/2022062504/5a4d1b647f8b9ab0599af400/html5/thumbnails/8.jpg)
Public sector borrowing
•Let G denote public sector (or government) spending for goods and services in a year
•T is net tax receipts in a year.
•If G is greater than T, the the public sector has a budget deficit equal to G – T.
•If T is greater than G, then the public sector has a surplus equal to T – G.
•If the public sector has a budget deficit, it must borrow.
![Page 9: The Loanable Funds theory We use the term “loanable funds market” to describe the arrangements and institutions by which saving of households is made available.](https://reader035.fdocuments.us/reader035/viewer/2022062504/5a4d1b647f8b9ab0599af400/html5/thumbnails/9.jpg)
-400
-300
-200
-100
0
100
200
300
55 60 65 70 75 80 85 90 95 00
www.economagic.com
Federal Government Budget Surplus (Deficit) in billions , 1955-2000
![Page 10: The Loanable Funds theory We use the term “loanable funds market” to describe the arrangements and institutions by which saving of households is made available.](https://reader035.fdocuments.us/reader035/viewer/2022062504/5a4d1b647f8b9ab0599af400/html5/thumbnails/10.jpg)
Public Sector Borrowing in ClassicaG = $2 trillionT = $1.25 trillionTherefore, Budget Deficit = G – T = $2 trillion - $1.25 trillion = $0.75 trillion
0.750
5%
3%
Government Demand for Funds
Inte
rest
Ra t
e
Trillions of Dollars
A
B
![Page 11: The Loanable Funds theory We use the term “loanable funds market” to describe the arrangements and institutions by which saving of households is made available.](https://reader035.fdocuments.us/reader035/viewer/2022062504/5a4d1b647f8b9ab0599af400/html5/thumbnails/11.jpg)
[1] [2] [3] = [1] + [2]Interest Rate Business Demand Government Demand Total Demand
5% 1.0 0.75 1.753% 1.5 0.75 2.25
Demand for Loanable Funds (in Trillions)
![Page 12: The Loanable Funds theory We use the term “loanable funds market” to describe the arrangements and institutions by which saving of households is made available.](https://reader035.fdocuments.us/reader035/viewer/2022062504/5a4d1b647f8b9ab0599af400/html5/thumbnails/12.jpg)
Inte
rest
Rat
e
Trillions of Dollars0
3%
5%
1.75 2.25
Total Demand for Funds
![Page 13: The Loanable Funds theory We use the term “loanable funds market” to describe the arrangements and institutions by which saving of households is made available.](https://reader035.fdocuments.us/reader035/viewer/2022062504/5a4d1b647f8b9ab0599af400/html5/thumbnails/13.jpg)
Inte
rest
Rat
e
Trillions of Dollars
Loanable Funds Market Equilibrium
Total Supply of Funds (Saving)
Total Demand for Funds (Investment + Deficit)
E5%
0 1.75
![Page 14: The Loanable Funds theory We use the term “loanable funds market” to describe the arrangements and institutions by which saving of households is made available.](https://reader035.fdocuments.us/reader035/viewer/2022062504/5a4d1b647f8b9ab0599af400/html5/thumbnails/14.jpg)
Why does the loanable funds theory guarantee the validity of Say’s law?
S = IP + G - T
Quantity of Funds Supplied
Quantity of Funds Demanded
Now, rearrange the equation above by bringing T to the left side:
S + T = IP + G
Leakages Injections
![Page 15: The Loanable Funds theory We use the term “loanable funds market” to describe the arrangements and institutions by which saving of households is made available.](https://reader035.fdocuments.us/reader035/viewer/2022062504/5a4d1b647f8b9ab0599af400/html5/thumbnails/15.jpg)
So long as the loanable funds market “clears,” leakages (Saving) will be offset to
injections (investment and government spending).
![Page 16: The Loanable Funds theory We use the term “loanable funds market” to describe the arrangements and institutions by which saving of households is made available.](https://reader035.fdocuments.us/reader035/viewer/2022062504/5a4d1b647f8b9ab0599af400/html5/thumbnails/16.jpg)
Firms
Government
Households
Resource Markets
GoodsMarkets
Loanable Funds Markets
Income ($7 Trillion)
Factor Payments ($7 Trillion)
Government Spending ($2 Trillion)
Investment ($1 Trillion)
Consumption ($4 Trillion)
Firm Revenues ($7 Trillion)
Deficit ($0.75 Trillion
Income ($7 Trillion)
Saving ($1.75 Trillion)
Net Taxes ($1.25 Trillion)
![Page 17: The Loanable Funds theory We use the term “loanable funds market” to describe the arrangements and institutions by which saving of households is made available.](https://reader035.fdocuments.us/reader035/viewer/2022062504/5a4d1b647f8b9ab0599af400/html5/thumbnails/17.jpg)
Changes in government spending, transfer payments, and taxes designed to change total spending in the economy and thereby influence total output and employment.
![Page 18: The Loanable Funds theory We use the term “loanable funds market” to describe the arrangements and institutions by which saving of households is made available.](https://reader035.fdocuments.us/reader035/viewer/2022062504/5a4d1b647f8b9ab0599af400/html5/thumbnails/18.jpg)
The Classical view of Fiscal policy
Friends, we believe that fiscal policy is unnecessary and
ineffective. The economy is doing just fine without meddling by
Washington.
![Page 19: The Loanable Funds theory We use the term “loanable funds market” to describe the arrangements and institutions by which saving of households is made available.](https://reader035.fdocuments.us/reader035/viewer/2022062504/5a4d1b647f8b9ab0599af400/html5/thumbnails/19.jpg)
•Crowding out is the idea that an increase in one component of spending will cause a decrease in other spending components.•An increase in G may cause a decrease in C, IP, or both—that is, government spending may “crowd out” private spending.
![Page 20: The Loanable Funds theory We use the term “loanable funds market” to describe the arrangements and institutions by which saving of households is made available.](https://reader035.fdocuments.us/reader035/viewer/2022062504/5a4d1b647f8b9ab0599af400/html5/thumbnails/20.jpg)
Inte
rest
Rat
e
Trillions of Dollars
Crowding Out With an Initial Budget DeficitTotal Supply of Funds (Saving)
D1 = IP + G1 - T
H5%
0 1.75
D2 = IP + G2 - T
7%
2.05 2.25
A C
B •Increase in G = AH•Decrease in C = AC•Decrease in IP = CH
![Page 21: The Loanable Funds theory We use the term “loanable funds market” to describe the arrangements and institutions by which saving of households is made available.](https://reader035.fdocuments.us/reader035/viewer/2022062504/5a4d1b647f8b9ab0599af400/html5/thumbnails/21.jpg)
Inte
rest
Rat
e
Trillions of Dollars
Effects of a Reduction in the Government Surplus
S1 = Savings + T – G1
D = Investment
B
5%
0 1.75
S2 = Savings + T – G2
AH
7%C
1.25 1.55