Suppose that in the U.S., the default risk in loanable funds increases. How does this affect the...

Question:

Suppose that in the U.S., the default risk in loanable funds increases.

How does this affect the interest rate differential?

Describe or graph how the market will react to this situation in full detail.

Loanable funds market:

Borrowers rely on loan through lenders on which borrowers have to pay certain rate of interest. The point at which demand for loanable funds equal supply of loanable funds, it gives us equilibrium interest rate and quantity of funds traded in the market.

Answer and Explanation:

As risk on loanable funds increased, it would induce people to save less and consume more or give loan to that individual whom you have full trust without fearing default risk. It would reduce the fund amount available in the market and shift the supply of loanable funds curve to its left while demand remain the same. As supply of loanable funds shifts to its left causing interest rate to rise and quantity of loanable funds to fall.


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Loanable Funds: Definition & Theory

from Introduction to Business: Homework Help Resource

Chapter 25 / Lesson 29
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