Loanable funds constitute the amount of money that an economy has available to lend.
Loanable funds are made up of the savings of those people or companies that are willing to lend that money and those who want to borrow. From the above we deduce, that the market where that money is traded is called the market of loanable funds.
Of course, the amount of loanable funds depends on many factors. For example, of factors such as interest rate, economic situation or political situation.
If the economic situation is very bad, less amount will be willing to lend. In the same way, fewer people will be willing to invest in new businesses.
Supply and demand of loanable funds
The market of loanable funds can be represented by a simple graph of supply and demand. But before representing it we will define some concepts well:
- Real interest rate:It is the price of borrowing. The bidder receives it and the plaintiff pays it.
- Offer of loanable funds:It is formed by the group of people, companies or institutions that have savings and are willing to lend.
- Demand for loanable funds:On the contrary, the demand is the set of economic agents that need money and are willing to borrow.
Thus, if we put the previous concept together into one, the resulting graph would be as follows:
Now we have supply, demand and interest rate together. For a given supply and demand amount there is an interest in balance. That is, the point at which bidders (savers) and claimants (investors) agree on determines the equilibrium interest rate. In this case 3%.
Of course, the evolution of loanable funds does not depend solely on supply, demand and interest rate. Since, in turn, each of these three factors can be changing according to different aspects. Aspects related to:
- Interest rate set by the central bank
- Economic policy
- Economic situation
- Fiscal policy
- Monetary politics
To know more about how these factors affect several things should be detailed. For example, it does not produce the same effect on the amount of funds available to be lent an expansive monetary policy , than a restrictive monetary policy.
Expansive monetary policy causes interest rates to fall to encourage investment. On the contrary, restrictive monetary policy raises interest rates to “cool” the economy.