Loanable funds are the amount of money that an economy has available to lend.
Loanable funds are formed by the savings of those people or companies that are willing to lend that money and those that want to borrow. From the above we then deduce that the market where that money is traded is called the loanable funds market.
Of course, the amount of loanable funds depends on many factors. For example, of factors such as the interest rate, the economic situation or the 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 for loanable funds can be represented by a simple supply and demand graph. But before representing it, we are going to define some concepts well:
- Real interest rate: It is the price of borrowing. The bidder receives it and the claimant pays for it.
- Offer of loanable funds: It is made up of 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 who need money and are willing to borrow.
With which, if we join the previous concepts in a single one, the resulting graph would be the following:
Now we have supply, demand and interest rate together. For a given quantity of supply and demand there is an equilibrium interest. That is, the point at which the bidders (savers) and demanders (investors) agree determines the equilibrium interest rate. In this case 3%.
Of course, the evolution of loanable funds does not depend only on supply, demand and interest rates. Since, in turn, each of these three factors can change according to different aspects. Aspects related to:
- Interest rate set by the central bank
- Inflation expectations
- Economic policy
- Economic situation
- Fiscal policy
- Monetary politics
To know more about how these factors affect, several things should be detailed. For example, an expansionary monetary policy does not produce the same effect on the amount of funds available to be borrowed as a restrictive monetary policy.
Expansive monetary policy causes interest rates to fall to encourage investment. On the contrary, tight monetary policy causes interest rates to rise to "cool down" the economy.
See loanable funds market