Loanable funds

In economics , the loanable funds theory (German also: Theory of loanable funds ) describes a theory for determining the interest rate . According to this theory, the market interest rate is determined by the supply and demand of credit. Loans in this sense are loans or securities.

history

The loanable funds theory goes back to the 1930s. It was formulated by the British economist Dennis Holme Robertson and the Swedish economist Bertil Ohlin . However, Ohlin attributed the origins of the theory to the Swedish economist Knut Wicksell and the so-called Stockholm School .

theory

The loanable funds theory extends the classic interest rate theory, which saw the interest rate determined solely by the interaction of savings and investment, to include bank loans. The total supply of credit in an economy can exceed private savings because the banking system is able to create loans out of nowhere. Because of this, the equilibrium rate (or market rate) is determined not only by saving and investment, but also by credit creation and credit cancellation.

When the banking system draws credit, it lowers the market rate below what is known as the natural rate . Wicksell had defined the natural interest rate as that interest rate which is compatible with price level stability. Credit creation and cancellation therefore not only affect the interest rate, but also the price level and economic activity.

Ohlin turned against the idea that interest is determined solely by savings and investment (op. Cit., P. 222): "One cannot say that the rate of interest equalises planned savings and planned investment, for it obviously does not do that . How, then, is the height of the interest rate determined. The answer is that the rate of interest is simply the price of credit, and that it is therefore governed by the supply of and demand for credit. The banking system - through its ability to give credit - can influence, and to some extent does affect, the interest level. "

In mathematical terms, the loanable funds theory determines the market interest rate by the following equilibrium condition:

${\ displaystyle PS + \ Delta B = PI.}$

The price level denotes the real savings and the real investment demand, while the credit creation symbolizes. Savings and investment are multiplied by the price level in order to convert them into nominal quantities, because credit creation is also a nominal quantity. ${\ displaystyle P, S, I}$ ${\ displaystyle \ Delta B}$

Because every credit creation in a fiat money system goes hand in hand with a deposit creation , the loanable funds theory can alternatively be represented by the formula . Both of the previous representations only apply to closed economies. In an open economy, capital exports must be added to credit demand. ${\ displaystyle \ Delta B = \ Delta M.}$ ${\ displaystyle PS + \ Delta M = PI}$

Comparison with the classical and Keynesian approach

The classical theory determines the interest rate solely through the interaction of savings and investment, i.e. through the equation changes in the money supply do not influence the interest rate, but only the price level ( quantity theory ). The Keynesian liquidity preference theory determines income and interest through the correspondence of saving and investment, and the correspondence of money demand and money supply, This is the well-known IS-LM model . Both the classical and the Keynesian approach demand the agreement of savings and investment in the ex ante sense . ${\ displaystyle S (i) = I (i).}$ ${\ displaystyle S (Y) = I (i)}$ ${\ displaystyle L (Y, i) = M / P.}$

In contrast to this, the loanable funds theory does not require that savings and investment coincide ex ante , but rather integrates credit creation by banks into the equilibrium condition. Ohlin thought this representation was more realistic: "There is a credit market ... but there is no such market for savings and no price of savings." If the commercial banks expand the supply of credit and money, the interest rate decreases in the same way as one additional savings.

During the 1930s, and then again during the 1950s, the relationship between loanable funds theory and liquidity preference theory was extensively discussed. Some authors considered both approaches to be equivalent. However, there is no consensus on this question.

Colloquial use of the term

While the term loanable funds theory is used consistently in the scientific literature in the above sense, textbook authors and bloggers occasionally use the words "loanable funds" in connection with the classical interest theory. This colloquial usage neglects the decisive contribution of the loanable funds theory, namely the integration of money and credit into interest rate determination.

Individual evidence

^ Robertson, DH (1934) Industrial Fluctuation and the Natural Rate of Interest. The Economic Journal , vol. 44, pp. 650-656. Quote p. 652: "If [after an industrial expansion], the banks keep the rate of interest right down, ... the initial rate of lendings per atom of time will exceed the rate of available new savings , and the whole of the excess ... will consist of newly-created bank money. "
↑ Ohlin, B. (1937) Some Notes on the Stockholm Theory of Savings and Investment II. The Economic Journal , vol. 47, pp. 221-240.
^ Wicksell, K. (1898) Money interest and prices of goods. Reprint 1968 Aalen: Scientia.
↑ Ohlin, B. (1937) Some Notes on the Stockholm Theory of Savings and Investment I. The Economic Journal , vol. 47, pp. 53-69. Ohlin explicitly names Erik Lindahl and Gunnar Myrdal as members of the Stockholm School .
↑ Tobin, J. (1963) Commercial Banks as Creators of 'Money'. Cowles Foundation Discussion Paper No. 159.
^ Ohlin, B. (1937) Alternative Theories of the Rate of Interest: Rejoinder. The Economic Journal vol. 47, p. 424.
↑ Patinkin, D. (1958) Liquidity Preference and Loanable Funds: Stock and Flow Analysis. Economica vol. 25, pp. 300-318.
^ Hansen, AH (1951) Classical, Loanable Fund, and Keynesian Interest Theories. Quarterly Journal of Economics vol. 65, pp. 429-432.
↑ Tsiang, SC (1956) Liquidity Preference and Loanable Funds Theories. American Economic Review 46, pp. 539-564.
↑ Mankiw, NG (2013) Macroeconomics . Eighth edition: Macmillan, p. 68.
↑ See for example Bill Mitchell: "The IMF fall into a loanable funds black hole again" , September 22, 2009.

[1] Robertson, DH (1934) Industrial Fluctuation and the Natural Rate of Interest. The Economic Journal , vol. 44, pp. 650-656. Quote p. 652: "If [after an industrial expansion], the banks keep the rate of interest right down, ... the initial rate of lendings per atom of time will exceed the rate of available new savings , and the whole of the excess ... will consist of newly-created bank money. "

[2] Ohlin, B. (1937) Some Notes on the Stockholm Theory of Savings and Investment II. The Economic Journal , vol. 47, pp. 221-240.

[3] Wicksell, K. (1898) Money interest and prices of goods. Reprint 1968 Aalen: Scientia.

[4] Ohlin, B. (1937) Some Notes on the Stockholm Theory of Savings and Investment I. The Economic Journal , vol. 47, pp. 53-69. Ohlin explicitly names Erik Lindahl and Gunnar Myrdal as members of the Stockholm School .

[5] Tobin, J. (1963) Commercial Banks as Creators of 'Money'. Cowles Foundation Discussion Paper No. 159.

[6] Ohlin, B. (1937) Alternative Theories of the Rate of Interest: Rejoinder. The Economic Journal vol. 47, p. 424.

[7] Patinkin, D. (1958) Liquidity Preference and Loanable Funds: Stock and Flow Analysis. Economica vol. 25, pp. 300-318.

[8] Hansen, AH (1951) Classical, Loanable Fund, and Keynesian Interest Theories. Quarterly Journal of Economics vol. 65, pp. 429-432.

[9] Tsiang, SC (1956) Liquidity Preference and Loanable Funds Theories. American Economic Review 46, pp. 539-564.

[10] Mankiw, NG (2013) Macroeconomics . Eighth edition: Macmillan, p. 68.

[11] See for example Bill Mitchell: "The IMF fall into a loanable funds black hole again" , September 22, 2009.