Macroeconomics
Let'srearrangetheFisherEquationtocalculatetherealinterestratewhengiventhenominalinterestrate and expected inflation rate:
● Nominal interest rate (i): 5% ● Expected inflation rate (π): 2%
Real interest rate (r) = nominal interest rate (i) − expected inflation rate (π)
Substituting the values:
r = 5% − 2% = 3%
So, in this example, if there isanominalinterestrateof5%onaninvestmentorloan,andtheinflation rate is expected to be 2%, the real interest rate (adjusted for inflation) would be 3%. This meansthat purchasing power would increase by approximately 3% after accounting for the effects of inflation. I. Loanable Funds Market The loanable funds market is a hypothetical fnancial market that illustrates the allocation of funds fromsavers(loansuppliers)toborrowers withinvestmentprojects(loandemanders).Inthismarket, the interaction between those who supply anddemandfundsoftenoccursindirectlythroughfnancial institutions, typicallybanks.Bankspayinteresttosaverswithsavingsaccountsandutilizethesefunds to provide loans to borrowers, charging them interest to make profts. In the loanable funds market, the interaction of those who demand loans and those whosupply them determines the quantity of loanable funds (Q LF )andtherealinterestrate(r.i.r) .Thismarket determines the real instead of the nominal interest rate because investors’ decisions are highly influencedbythechangeinthevalueofmoneyovertime(i.e.,thetimevalueofmoney)asexplainedin the previous section. The Loanable Funds Market Graph Likeallothermarketsexaminedsofar, equilibriumintheloanablefundsmarketisdeterminedbythe
intersection of the demand (D LF ) and supply (S LF )of loanable funds . The following components make up the loanable fundsmarket graph : ➔ Quantity of loanable funds on the horizontal axis ➔ Real interest rate on the vertical axis
➔ A downward-sloping demand curve of loanable funds(D LF ) .Thiscurverepresentsthe total amount of funds or loans that frms and households are willing and able to borrow . The negative slope of the curve indicates an inverse relationship betweentherealinterestrate andthequantitydemandedofloanablefunds :Astherealinterestrateincreases,thecostof borrowing increases, hence reducing the quantity demanded of loanable funds, and vice versa.
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