Question

Explain the impacts of Canadian firms learning positive economic news about the future in the context of the market for loanable funds. For example, when the price of oil increases following the unexpected news that Saudi Arabia and Russia have made up and agreed to lower production to support the price of oil. Contrast the impacts if Canada is better approximated by a closed economy versus if Canada is better approximated by an open economy. Your answers do not need to go outside the impacts in the market for loanable funds.

Answer 1

The classical and neoclassical theories on loanable funds outline a range of factors that influence the credit market conditions. Moreover, a practical approach to loanable funds market provides following insights on impact of positive news about future market conditions.

1. The present rate of interest would most likely see an upward trend in the expectation of growth in credit demand, assuming that credit supply remains the same.

2. The investors would move to firms offering loans in the expectation of better returns on their investment.

3. New firms having large amount of funds to offer as loan may enter the loan market in the hope of high profits.

Assuming Canada as a closed economy with supply of funds coming only from domestic firms and institutions, the effect may include-

A.High savings rate amongst the household sector, as the banks would raise the interest rates on deposits to attract more funds.

B. Relocation of credit to sectors promising highest returns on investment.

C. Development and Expansion of the credit market.

In contrast to this, if Canada is an open economy then following effects may be seen-

1. Global investors may pour in huge funds and moderate interest rate.

2. Firms undertaking activities pertaining to foreign trade may seek higher credit offtake in the wake of growing foreign trade.

3. Competition in the loan offering market would keep the rate of return on investment moderate and new domestic firms would weigh all options before entering the sector.