4.7 The Loanable Funds Market
The loanable funds market sets the real interest rate where the supply of saving meets the demand for borrowing to fund investment.
The supply of loanable funds comes from saving — private saving by households and firms plus public saving when the government runs a surplus. Supply slopes upward: higher real interest rates reward more saving. Demand comes from borrowers, mainly firms funding investment, and slopes downward: cheaper borrowing makes more projects profitable.
Equilibrium sets the REAL interest rate. Shift logic: more saving (or foreign capital inflows) shifts supply right and lowers the real rate; stronger investment demand or new government borrowing shifts demand right and raises it.
Keep the two interest-rate graphs straight: the money market uses the nominal rate with a vertical money supply set by the Fed; the loanable funds market uses the real rate driven by saving and borrowing behavior. Deficits and crowding out (Topic 5.5) live in this graph, not the money market.
Key terms for 4.7
Drag the curves yourself — the fastest way to make 4.7 stick.
Labeling the loanable funds y-axis 'nominal interest rate.' Loanable funds determines the REAL rate — the nominal rate belongs to the money market.
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