In: Economics
Draw a supply/demand diagram of the market for "loanable funds" in the U.S. Use the "interest rate" as the "price" of loanable funds on your diagram. Show and explain the effects (in your own words) of a rise in the expected inflation rate on your diagram. ( please do not copy from other page or other people)
Rise in the expected inflation will affect the mindset of both savers and borrowers . Now we know that inflation erodes away the real value of money . It will lower the real spending power of consumers in future . So savers do not wish to save at any given interest rate , since they know that they require more money at hand to keep their real consumption level and their real value of savings will be eroded away by infaltion . So supply of loanable funds fall in the market . Supply curve shifts left from S0 to S1 .
We know that inflation helps debtors and makes creditors worse off . Due to future expectations of inflation borrowers will like to borrow more and more at present at any interest rate . As the general price level rises the real value of the money borrowed falls . So they have to pay back lesser in real terms . Demand for loanable funds rise . It shifts right from D0 to D1 .
So both the effects cause the real interest rate to rise in the market . Change in equilibrium quantity is ambiguous and depends upon the degree of shift of both the curves .
New equilibrium is E1