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The Federal Reserve controls the amount of bank activity

The Federal Reserve controls the amount of bank activity and thus influences a wide variety of interest rates. The government also has an impact on the lending process by granting special tax treatment for different types of interest. Loanable Funds Theory. Extending the model

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The Federal Reserve controls the amount of bank activity

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  1. The Federal Reserve controls the amount of bank activity • and thus influences a wide variety of interest rates. • The government also has an impact on the lending process • by granting special tax treatment for different types of interest.

  2. Loanable Funds Theory • Extending the model • Financial institutions • Changes in supply • Household thrift • Changes in demand • Rate of return on investment • Other participants 14-2 LO2

  3. Supply Of Loanable Funds • In theory, supply and demand applies • Supply in many forms • Bank loans • Bonds • Stocks • Economists disagree how much $ is actually available to loan • Many variables

  4. Loanable Funds Theory The equilibrium interest rate S Interest Rate (Percent) i = 8% D 0 F0 Quantity of Loanable Funds 14-4 LO2

  5. Time-Value of Money • Money is more valuable the sooner it is obtained • Ability to earn interest • Compound interest • Future value • Present value 14-5 LO3

  6. Time Value of Money • Beginning Value Computation Total Interest End Value • $1,000 year 1 $1,000 X 1.10 = $1,100 $1,000 $1,100 • $1,100 year 2 • $1,210 year 3 14-6 LO4

  7. Time-Value of Money 14-7 LO3

  8. Time Value of Money • Works in the other way • What is an anticipated $1,000,000 in 2054 worth today? • Go to • Free On Line Calculator Use • Future Value of Money 14-8 LO3

  9. The Price of Credit • Effective interest rates • Discounting a loan • Repaying a loan in installments • Effects of compounding • Truth in Lending Act 1968 • Truth in Savings Act 1991 • Fees and teaser rates • Let the borrower beware 14-10 LO5

  10. Role of Interest Rates • Relationship to: • Total output • Allocation of capital • R&D spending • Nominal and real rates • Application: Usury Laws • Nonmarket rationing • Gainers and losers • Inefficiency 14-11 LO3

  11. Global Perspective 14-16 LO3

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