Market For Loanable Funds

Updated Jan 8, 2023

Definition of Market for Loanable Funds

The market for loanable funds describes the market for savings and investments. It is based on the idea that the demand for loanable funds comes from borrowers who want to invest in projects (i.e., businesses that demand funds), and the supply of loanable funds comes from savers who want to earn a return on their savings (i.e., households that supply funds).

Example

To illustrate this, let’s say a company wants to build a new factory. To do this, they need to borrow money somewhere. Meanwhile, assume that a retiree has saved up a large sum of money and wants to invest it in a safe and profitable asset. In that scenario, the two parties can both participate in the hypothetical market for loanable funds, where the retiree is a saver who provides funds to borrowers like the company.

The company can borrow the money from the retiree, or from any other saver (i.e., household) in the market. In return, the saver will receive a return on their investment in the form of interest payments. The company, on the other hand, will receive the money it needs to build the factory.

Why Market for Loanable Funds Matters

The market for loanable funds is an essential concept in economics because it helps to explain how savings and investments are connected. It also helps to explain how interest rates are determined and how they affect the economy. After all, investments are an important component of real GDP.

In addition to that, this financial market is important for understanding how governments and central banks can influence the economy. For example, governments can use fiscal policy to increase or decrease the demand for loanable funds, and central banks can use monetary policy to influence the supply of loanable funds.