The Loanable Funds Market
| English | Chinese | Pinyin |
|---|---|---|
| saving | 储蓄 | chǔ xù |
| investment | 投资 | tóu zī |
| loanable funds market | 可贷资金市场 | kě dài zī jīn shì chǎng |
| crowding out | 挤出效应 | jǐ chū xiào yìng |
| equilibrium real interest rate | 均衡实际利率 | jūn héng shí jì lì lǜ |
Where the real interest rate is set
- The money market sets the nominal rate right now.
- But borrowing and lending over time need a real rate.
- That comes from a separate market for saving and investment.
- It is the loanable funds market 可贷资金市场.
Saving supplies, investment demands
- The supply of loanable funds comes from saving 储蓄 — more saving at a higher real rate.
- The demand comes from borrowing for investment 投资 — more borrowing at a lower real rate.
- Where they cross is the equilibrium real interest rate 均衡实际利率.
Which way does the real rate move?
Government borrowing raises demand for funds and pushes the real rate up (crowding out); more saving shifts supply right and lowers it.
The supply of loanable funds comes from:
Saving supplies funds; borrowing for investment demands them.
The loanable funds market sets the ______ interest rate.
It sets the real rate for borrowing and lending over time.
The demand for loanable funds comes mainly from:
Firms and governments borrow to invest, demanding loanable funds.
Crowding out
- More government borrowing (a budget deficit) raises the demand for funds, pushing the real rate up.
- A higher real rate reduces private investment — an effect called crowding out 挤出效应.
- More household saving instead shifts supply right and lowers the real rate.
Heavy government borrowing raises the real interest rate and reduces private investment. This is called:
The higher real rate "crowds out" investment projects that no longer pay.
More household saving shifts the supply of loanable funds right and lowers the real interest rate.
A rightward supply shift lowers the equilibrium real rate.
A worked case
- Worked idea. A government runs a large deficit and borrows heavily.
- The demand for loanable funds shifts right, so the real interest rate rises from 3% to 5%.
- At that higher rate, some firms cancel investment projects that no longer pay.
- Government borrowing has "crowded out" private investment — the key long-run worry about deficits.
Government borrowing pushes the real rate from 3% to 5%. By how many percentage points did it rise?
The real rate rose by 5 − 3 = 2 percentage points, crowding out some investment.
The loanable funds market sets the real interest rate where saving (supply) meets investment (demand). Government borrowing raises demand and pushes the real rate up, reducing private investment — crowding out. More saving shifts supply right and lowers the real rate.