loanable funds

(noun)

Money available to be issued as debt.

Related Terms

Examples of loanable funds in the following topics:

  • Role in Providing a Market for Loanable Funds

    • In the loanable funds market, market clearing is defined as the interest rate/loanable funds quantity where savings equal investment (the amount of capital needed for property, plant, and equipment based investments) .
    • Loanable funds are typically cash, but can also include other financial assets to serve as an intermediary.
    • Loanable funds are often used to invest in new capital goods.
    • The interest rate can also describe the rate of return from supplying or lending loanable funds.
    • When the supply and demand for loanable funds are equal, savings is equal to investment and the loanable funds market is in equilibrium at the prevailing interest rate.

  • The Reserve Ratio

    • Therefore, banks with relatively higher deposits are able to supply a larger amount of loanable funds.
    • The supply of loanable funds directly impacts growth and interest rates in an economy.
    • Typically, an increase in the supply of loanable funds is associated with a decrease in interest rates.
    • The required reserve ratio is a tool in monetary policy, given that changes in the reserve ratio directly impact the amount of loanable funds available .
    • Alternatively, the higher the reserve requirement the, lower the supply of loanable funds, the higher the interest rate and the slower the resulting economic growth.

  • Managing the Business Cycle

    • Expansionary monetary policy relies on the central bank increasing availability of loanable funds through three mechanisms: open market operations, discount rate, and the reserve ratio.
    • As the supply of loanable funds increases, the interest rate is expected to decrease and thereby increase the desire to borrow funds for consumption and investment purposes.
    • Similarly, contractionary monetary policy is the opposite of expansionary monetary policy and occurs when the supply of loanable funds is limited, to reduce the access and availability to relatively inexpensive credit.

  • Crowding-Out Effect

    • What happens is that an increase in the demand for loanable funds by the government (e.g. due to a deficit) shifts the loanable funds demand curve rightwards and upwards, increasing the real interest rate.
    • If the economy is at capacity or full employment, then the government suddenly increasing its budget deficit (e.g., via stimulus programs) could create competition with the private sector for scarce funds available for investment, resulting in an increase in interest rates and reduced private investment or consumption.

  • Executing Restrictive Monetary Policy

    • By adjusting the reserve requirement, the Fed can effectively change the availability of loanable funds.
    • The interest rate on the overnight borrowing of reserves is called the federal funds rate or simply the "funds rate."
    • For example, if the supply of reserves in the fed funds market is lower than the demand, then the funds rate increases.
    • At higher fed funds rates, banks are more likely to limit borrowing and their provision of loanable funds, thereby decreasing access to loanable funds and reducing economic growth.
    • Contractionary monetary policy results in a reduction in the money supply, depicted as a leftward shift, which results in an increase in interest rates as well as a decrease in the quantity of loanable funds.

  • Open Market Operations

    • These include the discount rate, the fed funds target rate, and the reserve requirement, and open market operations (OMOs).
    • Historically, the Federal Reserve has used OMOs to adjust the supply of reserve balances so as to keep the federal funds rate--the interest rate at which depository institutions lend reserve balances to other depository institutions overnight--around the target established by the FOMC.
    • The interest rate targeted through the OMO manipulation of the money supply is the fed funds target rate or the rate that member Fed banks charge one another for overnight loans.
    • The target rate is important monetary tool from the perspective that the higher the fed funds rate relative to the return on loanable funds, the greater the incentive for banks to meet their reserve requirement (the bank will lose money) thereby placing limits on the growth of the money supply through the loanable funds market.
    • In addition to this direct interest rate channel, the fed funds rate influences many other interest rates in the economy and by so doing contributed to either incentivizing borrowing for growth or disincentivizing the same.

  • Role in Matching Savings and Investment Spending

    • In national accounting terms, stocks, bonds, mutual funds, and other cash equivalents, are not classified as investments but rather are classified as savings.
    • Assuming a closed economy, one where there is no export or impart activity to interfere with the domestic savings level, on an aggregate basis individual savings creates the supply of loanable funds available for investment purposes.
    • The amount of savings available in the economy is equal to the amount of funding available for investment activity.
    • Mutual funds, pension obligations, insurance annuities, and other forms of savings marketed by financial intermediaries all consist of stocks, bonds, and cash balances, which in turn pay for the investment capital that increases productivity, efficiency and output of goods and services.
    • Savings are used to fund investments, where investments are defined as expenditures on factory plants, equipment and homes.

  • The Discount Rate

    • The interest rate is an active target and is set as a target rate range by the Fed; it is conveyed to the public by the Federal Reserve Open Market Committee (FOMC) as the fed funds target rate (short for the Federal Funds rate).
    • However, the rate that the central bank actually cares about is the fed funds rate.
    • The Fed targets the rate for federal funds via its open market operations and seeks to be the lender of last resort by charging banks a higher rate than the federal funds rate .
    • Given that lending has an expansionary effect, to the extent that the fed funds target rate and discount rate diminish the profitability of excess loaning, these parameters place limits to the expansion of the money supply via the loanable funds market.
    • The discount rate is higher than the fed funds target rate and the variance serves as a disincentive for banks to seek funds or short-term borrowings from the Fed.

  • Executing Expansionary Monetary Policy

    • By adjusting the reserve requirement, the Fed can effectively change the availability of loanable funds.
    • These loans take place in a private financial market called the federal funds market.
    • The interest rate on the overnight borrowing of reserves is called the Federal Funds rate or simply the "fed funds rate."
    • For example, if the supply of reserves in the fed funds market is greater than the demand, then the funds rate falls, and if the supply of reserves is less than the demand, the funds rate rises.
    • Expansionary monetary policy will seek to reduce the fed funds target rate (a range).

  • The Federal Funds Rate

    • The Federal Funds rate (or fed funds rate) is the interest rate at which depository institutions (primarily banks) actively trade balances held at the Federal Reserve.
    • The Federal Funds rate is directly related to the interest rate paid by firms and individuals.
    • A high Federal Funds rate, therefore, has a contractionary effect on economic activity, while a low Federal Funds rate has an expansionary effect.
    • The graph shows the federal funds rate for the past fifty years.
    • Discuss the importance of the Federal Funds Rate as a monetary policy tool