Loanable Funds Model

The Loanable Funds Model helps us understand how interest rates are determined in the economy. It suggests that the supply of money available for loans comes from savers who deposit funds, while borrowers seek these funds for investments or consumption. When the supply of loanable funds exceeds demand, interest rates tend to drop, encouraging borrowing. Conversely, when demand outstrips supply, interest rates rise, making borrowing more expensive. This interaction between savers and borrowers ultimately balances the amount of money available for loans and the cost of borrowing, influencing economic activity.