ECN 506 Lecture Notes - Lecture 4: Real Interest Rate, Nominal Interest Rate, Loanable Funds

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20 Feb 2017
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Loanable funds theory: states that real interest rates are determined by supply and demand for loans. Recall that the financial system channels funds from savers to investors. The loanable funds theory assumes an economy"s savers and investors meet in a market for loans, where the savers lend to the investors. The interest rate is the price of a loan. It is what investors pay savers for using their funds. The interest rate is determined by the supply and demand for loans. There is only one type of loan in the economy, and only one interest rate. Savers lend directly to investors, ignoring the role of banks. The demand for loans is the level of investment in the economy. If investors decide to undertake more projects, they must borrow more. An economy"s supply of loans is determined by the economy"s saving, and the flow of loans moving across its national borders.

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