Chapter 2 Determination of Interest Rates

Chapter 2 Determination of Interest Rates

Outline

Loanable Funds Theory

Household Demand for Loanable Funds Business Demand for Loanable Funds Government Demand for Loanable Funds Foreign Demand for Loanable Funds Aggregate Demand for Loanable Funds Supply of Loanable Funds Equilibrium Interest Rate

Factors That Affect Interest Rates

Impact of Economic Growth on Interest Rates Impact of Inflation on Interest Rates Impact of Monetary Policy on Interest Rates Impact of the Budget Deficit on Interest Rates Impact of Foreign Flows of Funds on Interest Rates Summary of Forces That Affect Interest Rates

Forecasting Interest Rates

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Chapter 2: Determination of Interest Rates

Key Concepts

1. Explain the Loanable Funds Theory by deriving demand and supply schedules for loanable funds. 2. Explain the Fisher Effect, and tie it in with Loanable Funds Theory by explaining how inflation affects the demand and supply schedules for loanable funds. 3. Provide additional applications (especially current events) one at a time to help illustrate how events can affect the demand and supply schedules, and therefore influence interest rates. 4. Explain how forecasts of interest rates are needed to make financial decisions, which require forecasts of shifts in the demand and supply schedules for loanable funds. 5. Introduce several possible events simultaneously to illustrate how difficult it can be to forecast interest rate movements when several events are occurring at once.

POINT/COUNTER-POINT: Does a Large Fiscal Budget Deficit Result in Higher Interest Rates?

POINT: No. In some years (such as 2003), the fiscal budget deficit was large and interest rates were very low. COUNTER-POINT: Yes. When...