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DAY 5 PROBLEM SET Money Market (ANSWERS).pdf

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Define (using graphs as appropriate) the loanable funds market, demand for loanable funds, and supply of loanable funds.

Explain (using graphs as appropriate) the relationship between the real interest rate and the quantity of loanable funds demanded (supplied).

Define national savings in both a closed and an open economy.

Define (using graphs as appropriate) equilibrium in the loanable funds market.

Explain (using graphs as appropriate) how real interest rates adjust to restore equilibrium in the loanable funds market.

Explain (using graphs as appropriate) the determinants of demand and supply in the loanable funds market.

Explain (using graphs as appropriate) how changes in demand and supply in the loanable funds market affect the equilibrium real interest rate and equilibrium quantity of loanable funds.

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The interaction of borrowers, who demand loanable funds, and savers, who supply loanable funds, determines the equilibrium real interest rate.

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The loanable funds market describes the behavior of savers and borrowers.

The demand for loanable funds shows the inverse relationship between real interest rates and the quantity demanded of loanable funds.

The supply of loanable funds shows the positive relationship between real interest rates and the quantity supplied of loanable funds.

In the absence of international borrowing and lending, national savings is the sum of public savings and private savings.

For an open economy, investment equals national savings plus net capital inflow.

In the loanable funds market, equilibrium is achieved when the real interest rate is such that the quantities demanded and supplied of loanable funds are equal.

Disequilibrium real interest rates create surpluses and shortages in the loanable funds market. Market forces drive real interest rates toward equilibrium.

The loanable funds market can be used to show the effects of government spending, taxes, and borrowing on interest rates.

Factors that shift the demand (such as an investment tax credit) and supply (such as changes in saving behavior) of loanable funds change the equilibrium interest rate and the equilibrium quantity of funds.

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APMac Unit 4 Lesson 7 - The Loanable Funds Market

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APMac Unit 4 Lesson 7 - The Loanable Funds Market study guide by jclerch includes 4 questions covering vocabulary, terms and more. Quizlet flashcards, activities and games help you improve your grades.

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On June 10th, 2018, Swiss voters participated in a referendum on the very nature of money creation in their small alpine republic. The so-called "Vollgeld Initiative," or "sovereign money initiative," on their ballots would have required Swiss commercial banks to fully back their "demand deposits" in central bank money, effectively stripping private banks of their power to create money through loans in the current fractional reserve banking system.

In the build-up to this poll, the Swiss National Bank (SNB) tailored their statements on credit creation based on their audience: when speaking to the public, the SNB chose to promulgate an outdated "loanable funds" model of money creation, while it adopted an endogenous theory of credit creation when speaking to market participants. This served to mollify both audiences, reassuring them of the ability and sophistication of the SNB. Yet the contradicting stories offered by the SNB are part of a broader trend that has emerged as central banks have expended tremendous effort on trying to communicate their operations, with different banks offering different explanations for how money is
created. This risks damaging public trust in money far more than any referendum could.

At the SNB annual General Shareholders Meeting in April 2018, Governor Thomas Jordan was verbally confronted by two members of the audience who demanded Jordan explain how money is created - Jordan's understanding of credit, they argued, was flawed and antiquated. Faced with this line of questioning, Jordan rebutted that banks use sight deposits from other customers to create loans and credit. The audience members pushed back in disagreement, but Jordan did not waver.On the surface, Jordan's claim on money creation is an explanation one would find in most economics textbooks. In this common story, banks act as mere intermediaries in a credit creation process that transforms savings into productive investment.

However, only months earlier, Governor Jordan told a different story in a speech delivered to the Zürich Macroeconomics Association. Facing an audience of economists and market professionals, Jordan had embraced a portrayal of money creation that is more modern but starkly opposed to the more folk-theoretical, or "textbook" view. Jordan described how "deposits at commercial banks" are created: In the present-day financial system, when a bank creates a loan, "an individual bank increases deposits in the banking system and hence also the overall money supply." This is the antithesis of the folk theory offered to the public, presenting a glaring contradiction. Yet the SNB's duplicity is part of a broader trend: central banks are unable to provide a unified message on credit creation, both internally and among themselves.

For instance, in 2014, the Bank of England published a short, plainly-written paper that described in detail how commercial banks create money essentially out of nothing, by issuing loans to their customers. The Bank author's noted that "the reality of how money is created today differs from the description found in some economics textbooks," and sought to correct what they perceived as a popular misinterpretation of the credit creation process. Norges Bank, Norway's monetary authority, has made a similar push to clarify that credit creation is driven by commercial banks, rather than by printing presses in the basement of the central bank. Nonetheless, other central banks, such as the Bundesbank, have gone to great lengths to stress that monetary authorities have strict control the money supply. As economist Rüdiger Dornbusch , the German saving public "have been brought up to trust in the simple quantity theory" of money, "and they are not ready to believe in a new institution and new operating instructions."

***

While this debate over the mechanics of money creation may seem arcane, it has crucial implication for central bank legitimacy. During normal times, trust in money is built through commonplace uses of money; money works best when it can be taken for granted. As the sociologist Benjamin Braun notes, a central bank's legitimacy depends in part on it acting in line with a dominant, textbook theory of money that is familiar to its constituents. Yet this is no longer the case. Since the financial crisis, this trust has been shaken, as exemplified by Switzerland's referendum on sovereign money in June 2018. Faced with political pressures and uncertain macroeconomic environments, some central banks have had to be much more proactive about their communications, and much more frank about the murky nature of money. As quantitative easing has stoked public fears of price instability, monetary authorities including the Bank of England have sought to clarify who really produces money. In this sense, taking steps to inform the public on the real source of money - bank loans - is a worthwhile step, as it provides constraints on what a central bank can be reasonably expected to do, and reduces informational asymmetries between technical experts and lay citizens. On the other hand, a number of central banks have taken the dangerous approach of simply tailoring their message based on their audience: when speaking to technical experts, say one thing, and when speaking to the public, say another. The janus-faced SNB is a case in point. This rhetorical duplicity is important as it allows central banks to both assuage popular concerns over the stability of money, by fostering the illusion that they maintain control over price stability and monetary conditions, while similarly soothing markets with the impression that they possess a nuanced and empirically accurate framework of how credit creation works. For both audiences, this produces a sense of institutional commitment which sustains both public and market trust in money under conditions of uncertainty.

Yet this newfound duplicity in central bank communications is perilous, and risks further undermining public trust in money should they not succeed in straddling this fine line. Continuing to play into folk theories of money as these drift further and further away from the reality of credit creation will inevitably have unsettling ramifications. For example, it might lead to the election of politicians keen to exploit and pressure central banks, or the production of crises in the form of bank runs.

Germany's far-right Alternative für Deutschland , for instance, was founded and achieved its initial popularity as a party opposed to the allegedly inflationary policies of the European Central Bank, which failed to adequately communicate the purpose of its expansionary post-crisis monetary program. Once a central bank's strategies and the public's understanding of money become discordant, they lose the ability to assure their constituents of the continued functioning of money, placing their own standing at risk.

Central banks would be better off engaging in a clear, concise, and careful communications program to inform the public of how credit actually works, even if they might not really want to know how the sausage gets made. Otherwise, they risk further shaking public trust in critical monetary institutions.
About the Author: Pierre Ortlieb is a graduate student, writer, and researcher based in London. He is interested in political economy and central banks, and currently works at a public investment think tank (the views expressed herein do not represent those of his employer).

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Central Banks and the Folk Tales of Money - Economic Questions

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On June 10th, 2018, Swiss voters participated in a referendum on the very nature of money creation in their small alpine republic. The so-called "Vollgeld Initiative," or "sovereign money initiative," on their ballots would have required Swiss commercial banks to fully back their "demand deposits" in central bank money, effectively stripping private banks of their power to create money through loans in the current fractional reserve banking system.

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1. Can you graph the loanable funds market?

2. Can you describe crowding out, and the effect that crowding out has on the real interest rate in the loanable funds market?

3. Can you describe crowding in, and the effect that crowding in has on the real interest rate in the loanable funds market?

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Macroeconomics of Loanable Funds & Endogenous Money

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Macro 4.14- Loanable Funds & Crowding Out

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Mr. Clifford explains the graph for loanable funds and crowding out