Question

(a) examine the factors important in determining demand for and supply of loanable funds and show how the equilibrium interest rate is determined graphically. (b) differentiate between qualitative and quantitative methods of credit control. which are more effective in an inflationary situation

Answer 1

a)Supply of loanable funds depend on factors like savings , dishoarding,bank money and disinvestment.Savings by households and firms are the biggest source of loanable funds . Dishoarding implies bringing out money which is hoarded. Disinvestment means sufficient funds are not provided for depreciation of equipment.High rate of interest on loanable funds encourage disinvestment.Demand for investment is the most important factor for the demand for loanable funds .Investment means fund needed for expenditure on new capital goods and inventories. Dissaving is another factor . It is negative saving ie consuming more than income .Purchase of houses and household goods when there is no saving and paying in installments is an example.Lonable funds are also demanded for hoarding.The rate of interest is determined where demand curve intersects the supply curve.At any other rate there will be disequilibrium in the loanable fund market and it will try to come up to the level of equilibrium in the market.At the equilibrium rate of interest planned saving will be equal to planned investment.

b)Quantitative method is used to control the volume of credit in the economy through open market operation ,bank rate , CRR, SLR ,Repo rate etc. Qualitative method control's credit through direct auction, moral suasion,consumer credit regulations , margin requirements etc.Quantitative control aim at controlling all the sectors in the economy ie the overall volume of bank credit but qualitative control aim at selective sectors.The effectiveness of qualitative control is less.However quantitative control has their own merit .During inflation if quantitative credit control is applied it might pull the economy down to depression.So economists prefer qualitative credit control during inflation .