Chapter 24

1. Michael is an Internet service provider. On December 31, 2007,

he bought an existing business with servers and a building worth
$400,000. During his first year of operation, his business grew
and he bought new servers for $500,000. The market value of
some of his older servers fell by $100,000.
a. What was Michael’s gross investment, depreciation, and net
investment during 2008?
Michael’s gross investment was $500,000, his depreciation was
$100,000, and his net investment was $400,000.

b. What is the value of Michael’s capital at the end of 2008?

Michael’s capital at the end of 2008 is equal to his capital at
the beginning of 2008, $400,000, plus his net investment during
the year, also $400,000, for a total of $800,000.

2. Lori is a student who teaches golf on the weekend and in a year

earns $20,000 after paying her taxes. At the beginning of 2007,
Lori owned $1,000 worth of books, CDs, and golf clubs and she
had $5,000 in a savings account at the bank. During 2007, the
interest on her savings account was $300 and she spent a total
of $15,300 on consumption goods and services. There was no
change in the market values of her books, CDs, and golf clubs.
a. How much did Lori save in 2007?
Lori’s saving equalsher disposable incomeminus her consumption
expenditure.Lori’sdisposableincomeis$20,000plustheinterest
on her savings account, $300, for a total of $20,300.Her
consumption expenditure is $15,300, so her saving is $5,000.

b. What was her wealth at the end of 2007?

Lori’swealthattheend of 2007 is equal to the value of her wealth
at the beginning of 2007 plus her saving during the year. At the
beginningof2007Lori’swealthis$6,000—the value of her books,
CDs, golf clubs, and savings account. Lori saved $5,000 during
2007 so her wealth at the end of 2007 is $11,000.
3. First Call, Inc. is a cellular phone company. It plans to build
an assembly plant that costs $10 million if the real interest
rate is 6 percent a year. If the real
interest rate is 5 percent a year,
First Call will build a larger
plant that costs $12 million. And
if the real interest rate is 7
percent a year, First Call will
build a smaller plant that costs $8
million.
a. Draw a graph of First Call’s
demand for loanable funds curve.
Figure 7.1 shows First Call’s
demand for loanable funds curve.

b. First Call expects its profit from

the sale of cellular phones to double next year. If other
things remain the same, explain how this increase in expected
profit influences First Call’s demand for loanable funds.
When First Call expects its profit to increase, First Call
increases its investment. The increase in its investment leads
First Call to increase its demand for loanable funds.

4. Draw a graph to illustrate how an

increase in the supply of loanable
funds and a decrease in the demand
for loanable funds can lower the
real interest rate and leave the
equilibrium quantity of loanable
funds unchanged.
Figure 7.2 shows the effect of an
increase in the supply of loanable
funds and a decrease in the demand
for loanable funds. The supply of
loanable funds curve shifts
rightward from SLF0 to SLF1, and the
demand for loanable funds curve shifts leftward from DLF0 to DLF1.
The magnitude of the increase in supply is equal to the magnitude
of the decrease in demand, so the real interest rate falls (from
 7 percent to 4 percent in the figure) and the quantity of loanable
funds does not change (staying at $2.5 trillion in the figure).

5. The table shows an Real Loanable Loanable

economy’s demand for interest funds funds
loanable funds and the rate demanded supplied
supply of loanable (percent per (trillions of 2000
funds schedules, when year) dollars)
the government’s 4 8.5 5.5
budget is balanced. 5 8.0 6.0
a. If the government has 6 7.5 6.5
a budget surplus of $1 7 7.0 7.0
trillion, what are 8 6.5 7.5
the real interest 9 6.0 8.0
rate, the quantity of 10 5.5 8.5
investment, and the
quantity of private saving? Is there any crowding out in this
situation?
The real interest rate is 6 percent, the quantity of investment
is $7.5 trillion, and the quantity of private saving is $6.5
trillion. There is no crowding out.

b. If the government has a budget deficit of $1 trillion, what

are the real interest rate, the quantity of investment, and
the quantity of private saving? Is there any crowding out in
this situation?
The equilibrium real interest rate becomes 8 percent, the quantity
of investment is $6.5 trillion, and the quantity of private saving
is $7.5 trillion. There is crowding out of $500 billion of
investment.

c. If the government has a budget deficit of $1 trillion and the

Ricardo-Barro effect occurs, what are the real interest rate
and the quantity of investment?
The equilibrium real interest rate remains 7 perc
ent and the quantity of investment remains $7.0 trillion. There
is no crowding out because the $1 trillion increase in the budget
deficit leads to an offsetting $1 trillion increase in private
saving.
6. In the loanable funds market in problem 5, the quantity of
loanable funds demanded increases by $1 trillion at each real
interest rate and the quantity of loanable funds supplied
increases by $2 trillion at each interest rate.
a. If the government budget is balanced, what are the real
interest rate, the quantity of loanable funds, investment,
and private saving? Does any crowding out occur?
The table shows the
Real Loanable Loanable
demand for loanable
interest funds funds
funds and supply of
rate demanded supplied
loanable funs
(percent per (trillions of 2000
schedules. The new
year) dollars)
real interest rate is
4 9.5 7.5
6 percent, and the
5 9.0 8.0
quantity of loanable
6 8.5 8.5
funds, private saving,
7 8.0 9.0
and investment are all
8 7.5 9.5
$8.5 trillion. There
9 7.0 10.0
is no crowding out.
10 6.5 10.5
b. If the government
budget becomes a deficit of $1 trillion, what are the real
interest rate, the quantity of loanable funds, investment,
and private saving? Does any crowding out occur?
The equilibrium real interest rate becomes 7 percent. The
equilibrium quantity of loanable funds is $9.0 trillion, the
equilibrium quantity of investment is $8.0 trillion, and the
equilibrium quantity of private saving is $9.0 trillion. There
is crowding out of $500 billion of investment.

c. If governments want to stimulate the quantity of investment

and increase it to $9 trillion, what must they do?
Assuming no Ricardo-Barro effect, the government needs to have
a budget surplus of $1 trillion. In this case, the new equilibrium
is at a real interest rate of 5 percent. The quantity of investment
is $9 trillion and the quantity of private saving is $8 trillion.

7. In a speech at CFA Society of Nebraska, on February 2007, William

Poole, former Chairman of the St. Louis Federal Reserve said,
“Overmostofthepost-World War II period, the personal saving
rate averaged about 6 percent, with some higher years from the
 mid 1970s to mid 1980s. The negative trend in the ... saving
rate started in the mid 1990s, about the same time the stock
market boom started. Thus it is hard to dismiss the hypothesis
that the decline in the measured saving rate in the late 1990s
reflected the response of consumption to large capital gains
from corporate equity [stock]. Evidence from panel data of
households also supports the conclusion that the decline in
the personal saving rate since 1984 is largely a consequence
of capital gains on corporate equities [stocks].”
a. Is the purchase of corporate equities part of household
consumption or saving? Explain your answer.
The purchase of corporate equities, that is, shares of corporate
stock, is part of household saving. Consumption refers to the
purchase of goods and services that are then consumed, but
corporate equities are not consumable goods or services.

b. Equities reap a capital gain in the same way that houses reap
a capital gain. Does this mean that the purchase of equities
is investment? If not, explain why it is not.
The purchase of equities is not an investment because investment
refers to the purchase of physical capital. Equities are not
physical capital and so they are not investment.

c. U.S. household income has grown considerably since 1984. Has

U.S. saving been on a downward trend because Americans have
felt wealthier?
Even though U.S. household income has grown, the fall in U.S. saving
mightbebecausepeople’swealth has increased because the higher
a household’s wealth, the smaller is its saving.

d. Explain why households preferred to buy corporate equities

rather than bonds.
When the market value of corporate equities increases, households
that own the equities receive a capital gain, which increases their
wealth. Bonds only deliver a capital gain when the interest rate
falls because the interest rate on a bond falls when the price
of the bond rises. Interest rates do not consistently fall.
Interest rates fluctuate, so capital gains are interspersed with
capital losses for bonds. For many years, stocks experienced
ongoing capital gains. So households apparently believed that the
risk-adjusted return on corporate equities, which includes
 capital gains, exceeded the risk-adjusted return on bonds.

8. The Global Saving Glut and the U.S. Current Account, remarks
by Fed Chairman Ben Bernanke (when a governor of the Federal
Reserve) on March 10, 2005:
On most dimensions the U.S. economy appears to be performing
well. Output growth has returned to healthy levels, the labor
market is firming, and inflation appears to be well controlled.
However, one aspect of U.S. economic performance still evokes
concernamongeconomistsandpolicymakers:thenation’slarge
and growing current account deficit [negative net exports]. ...
Mostforecastersexpectthenation’scurrentaccountimbalance
to decline slowly at best, implying a continued need for foreign
credit and a concomitant decline in the U.S. net foreign asset
position. Bernanke went on to ask the following questions. What
are your answers to his questions:
a. Why is the United States, with the world’s largest economy,
borrowing heavily on international capital markets—rather
than lending, as would seem more natural?
At the world real interest rate the quantity of loanable funds
demanded in the United States exceeds the quantity of loanable
funds supplied. The surprising aspect of this point is that the
quantity of loanable funds is low in the United States because
U.S. disposable income is so high.

b. What implications do the U.S. current account deficit

(negative net exports) and our consequent reliance on foreign
credit have for economic performance in the United States?
The United States is borrowing from abroad to meet the demand for
loanable funds. With the borrowing, the quantity of loanable funds
in the United States is larger than otherwise, which means that
the quantity of investment projects funded is larger than
otherwise. As a result, the U.S. capital stock is larger than
otherwise, which helps enhance U.S. economic performance. However,
the United States will need to repay its loans from the rest of
the world and this repayment will detract from U.S. citizens’
well-being.
 c. What policies, if any, should be used to address this
situation?
If the goal is to decrease U.S. borrowing from abroad, then either
the U.S. demand for loanable funds needs to decrease or the U.S.
supply of loanable funds needs to increase. Increasing the
quantity of U.S. loanable funds seems to be the more reasonable
policy, so policy proposals need to focus on increasing savings.
Government policies to boost private saving might include tax
policies that exempt the return from saving from taxation.
Additionally government policies that decrease the size of the
budget deficit and perhaps move the government budget to a surplus
also would decrease U.S. borrowing from abroad.

9. The New New World Order

... While gross domestic product growth is cooling a bit in
emerging markets, the results are still tremendous compared
with the United States and much of Western Europe. The 54
developing markets surveyed by Global Insight will post a 6.7%
jump in real GDP this year, down from 7.5% last year. The 31
developed countries will grow an estimated 1.6%. The difference
in growth rates represents the largest spread between developed
and developing markets in the 37-year history of the survey.
Fortune, July 14, 2008
a. Do growth rates of real GDP over the past few decades indicate
that world saving is shrinking, growing, or staying the same?
Explain.
It is likely that world saving is growing. As disposable income
grows, saving grows since higher disposable income increases
saving.

b. If the world demand for loanable funds remains the same, will
the world real interest rate rise, fall, or remain the same?
Explain.
If the world demand for loanable funds remains the same, the growing
supply of loanable funds leads to a falling real interest rate.

10. IMF Warning Over Slowing Growth

The global economy may face a marked slowdown next year as a
result of the turmoil in financial markets, the International
Monetary Fund has warned. The IMF said the global credit squeeze
 would test the ability of the economy to continue expanding
at recent rates. While future economic stability could not be
taken for granted, there was plenty of evidence that the global
economy remained durable, it added.
BBC News, October 10, 2007
a. Explain how turmoil in global financial markets might affect
the demand for loanable funds, investment, and global economic
growth in the future.
The turmoil in financial markets leads some people to decrease
their saving because of fear that they might lose these funds due
to the turmoil; in other words, default risk increases. As a result,
the supply of loanable funds decreases, which pushes up the real
interest rate. The primary source demanding loanable funds is
business firms who want these funds to make investment. If the
real interest rate rises, the quantity of loanable funds demanded
decreases as businesses cancel no-longer profitable investments.
With less investment there will be less capital and so the growth
in potential GDP slows.

b. What might be the evidence that the global economy will

continue to grow?
Growth will remain if investment continues to be robust.
Investment depends on the real interest rate and expected profit.
At the time of the report, there seemed to be little sign that
the“globalcreditsqueeze”wasresultinginasharplyhigherreal
interest rate, which would serve to decrease investment. The
historical evidence is that the demand for and supply of loanable
funds increase at about the same rate, so there is no upward trend
intherealinterestrate.AdditionallytheIMF’sreportdoesnot
explicitly mention a higher real interest rate. It also is likely
that profit expectations have not plummeted. Survey data could
be used to try to get a read on profit expectations. But perhaps
more objectively, real GDP continued to expand at a reasonably
fast clip in many countries and this relatively rapid expansion
probably increased future profit opportunities.

11. Annie runs a fitness center. On December 31, 2008, she bought
an existing business with exercise equipment and a building
worth $300,000. During 2009, business improved and she bought
some new equipment for $50,000. At the end of 2009, her equipment
 and buildings were worth $325,000. Calculate Annie’s gross
investment, depreciation, and net investment during 2009.
Annie’snetinvestmentduring2009is$25,000becausethatisthe
change in her capital stock. Annie’s gross investment is $50,000
because that is her total purchase of capital equipment in 2009.
Annie’s depreciation during 2009 is $25,000 because Annie’s net
investment, $25,000, equals her gross investment, $50,000, minus
her depreciation.

12. Karrie is a golf pro, and after she paid taxes, her income from
golf and interest from financial assets was $1,500,000 in 2008.
At the beginning of 2008, she owned $900,000 worth of financial
assets.Attheendof2008,Karrie’sfinancial assets were worth
$1,900,000.
a. How much did Karrie save during 2008?
Karrie’s wealth increased by $1,000,000 in 2008. So her saving
in 2008 is $1,000,000. (This point assumes no capital gains or
losses on her stocks and bonds.)

b. How much did she spend on consumption goods and services?

Her income after taxes was $1,500,000. Her consumption equals her
income minus her saving, which is $1,500,000  $1,000,000 =
$500,000.

13. In 2008, the Lee family had a disposable income of $80,000,

wealth of $140,000, and an expected future income of $80,000
a year. At a real interest rate of 4 percent a year, the Lee
family saves $15,000 a year; at a real interest rate of 6 percent
a year, they save $20,000 a year;
and at a real interest rate of
8 percent, they save $25,000 a
year.
a. DrawagraphoftheLeefamily’s
supply of loanable funds
curve.
Figure 7.3 shows the Lee
family’s supply of loanable
funds curve.

b. In 2009, suppose that the stock

market crashes and the default
 risk increases. Explain how this increase in default risk
influences the Lee family’s supply of loanable funds curve.
If default risk increases the Lee family will decrease its saving.
As a result, the Lee family’s supply of loanable funds decreases
and its supply of loanable funds curve shifts leftward.
14. Draw a graph to illustrate the effect of an increase in the
demand for loanable funds and an even larger increase in the
supply of loanable funds on the real interest rate and the
equilibrium quantity of loanable funds.
Figure 7.4 shows the effect of an
increase in the demand for
loanable funds and an even larger
increase in the supply of loanable
funds. The demand curve shifts
rightward from DLF0 to DLF1, and
the supply curve shifts rightward
from SLF0 to SLF1. The increase in
supply is larger than the increase
in demand, so the real interest
rate falls (from 6 percent to 5
percent in the figure) and the
quantity of loanable funds
increases (from $2.3 trillion to $2.7 trillion in the figure).
15. India’s Economy Hits the Wall
Just six months ago, India was looking good. Annual growth was
9%, corporate profits were surging 20%, the stock market had
risen 50% in 2007, consumer demand was huge, local companies
were making ambitious international acquisitions, and foreign
investment was growing. Nothing, it seemed, could stop the
forward march of this Asian nation. But stop it has. ... The
country is reeling from 11.4% inflation, large government
deficits,andrisinginterestrates.…Mosteconomicforecasts
expect growth to slow to 7%—a big drop for a country that needs
to accelerate growth, not reduce it. … A June 16 report by
Goldman Sachs’ Jim O’Neill and Tushar Poddar … urges India to
improve governance, raise educational achievement, and control
inflation. It also advises … liberalizing its financial
markets. …
BusinessWeek, July 1, 2008
a. Suppose that the Indian government reduces its deficit and
gets back to a balanced budget. If other things remain the
same, how will the demand or supply of loanable funds in India
change?
If the Indian government reduces its deficit, the demand for
loanable funds decreases.

b. With economic growth forecasted to slow, future incomes are

expected to fall. If other things remain the same, how will
the demand or supply of loanable funds in India change?
If expected future incomes slow, the major effect is an increase
in the supply of loanable funds as households’ increase their
saving.

16. The Global Savings Glut and its Consequences

The world is experiencing an unprecedented glut of savings,
driving down real interest rates. It is a good time to borrow
rather than lend. … Several developing countries are running
large current account surpluses (representing an excess of
savings over investment). … China has the biggest surplus of
$1.2 trillion, but other developing countries put together have
accumulatedalmostasmuch.…Rapidgrowthleadstohighsaving
rates: people save a large fraction of additional income. In
 India, GDP growth has accelerated from 6% to 9%, lifting the
saving rate from 23% a decade ago to 33%today.China’ssaving
rate is a dizzy 55%. Not even the investment boom in Asia can
absorb these huge savings, which are therefore put into U.S.
bonds. When a poor country buys U.S. bonds, it is in effect
lending to the United States.
The Cato Institute, June 8, 2007
a. Graphically illustrate and
explain the impact of the
“unprecedented glut of savings”
on the real interest rate and the
quantity of loanable funds.
Figure 7.5 shows the global
loanable funds market. In the world
market for loanable funds the
supply of loanable funds—the
so-called “glut of savings”—has
significantly increased the supply
of loanable funds. The supply curve
shifts rightward from SLF0 without
the“glut”toSLF1 with it. The increase in the supply of loanable
funds lowers the real interest rate, in the figure from 6 percent
to 4 percent, and increases the quantity of loanable funds, in
the figure from $23 trillion to $25 trillion.

b. How do the high saving rates in China and India impact

investment in the United States? How does this investment
influence the production function and potential GDP in the
United States?
The highs savings rates impact the United States by lowering the
real interest rate in the United States. U.S. investment increases
(as does U.S. borrowing from abroad). The increase in investment
boosts the U.S. capital stock. As a result, the U.S. aggregate
production function shifts upward and U.S. potential GDP
increases.

17. ... Most economists agree that the problems we are witnessing
today developed over a long period of time. For more than a
decade, a massive amount of money flowed into the United States
from investors abroad, because our country is an attractive
 and secure place to do business. This large influx of money
to U.S. banks and financial institutions—along with low
interest rates—made it easier for Americans to get credit.
These developments allowed more families to borrow money for
cars and homes and college tuition—some for the first time.
They allowed more entrepreneurs to get loans to start new
businesses and create jobs.
President George W. Bush, Address to the Nation, September 24, 2008.
a. Explain why, for more than a decade, a massive amount of money
flowed into the United States and compare and contrast your
explanation with that of the President.
Financial funds flow throughout the world seeking the highest
risk-adjusted return. The risk-adjusted real interest rate in the
United States was higher than that in many other countries so funds
flowed vigorously into the United States.Mr. Bush’sexplanation
was similar but did not point out the desirability of investing
in the United States because of the higher risk-adjusted interest
rate.

b. Explain why interest rates were low using the loanable funds
analysis.
In the United States the world real interest rate was lower than
what would have been the U.S. real interest rate in the absence
of international capital mobility. At the world real interest rate
there was a shortage of loanable funds in the United States, so
the United States borrowed from abroad. Because the United States
could borrow at the world real interest rate, the interest rate
in the United States was lower than would otherwise have been the
case.

c. Provide a graphical analysis of

the reasons why the interest rate
was low.
Figure 7.6 shows the U.S. market for
loanable funds and the world real
interest rate, assumed to be 4
percent. In the figure, if there was
no international lending and
borrowing the real interest rate in
the United States would be 6 percent,
 the interest rate that sets the quantity of loanable funds demanded
in the United States equal to the quantity supplied. However the
United States can borrow from abroad. When the United States
borrows from abroad, the real interest rate equals the world real
interest. In the figure the real interest rate in the United States
is 4 percent and the United States borrows $0.5 trillion from the
rest of the world.

d. Funds have been flowing into the United States since the early
1980s. Why might they have created problems in 2008 but not
earlier?
The financial landscape was different in 2008 than in earlier years.
By 2008 the quantity of mortgage loans in the United States had
exploded over the past few years. Additionally in 2008 the real
interest rate had risen and many homeowners were unable to make
the scheduled repayments on their mortgages. They defaulted on
their mortgages and by so doing drove many financial firms into
insolvency. Compared to previous years, 2008 was unique and hence
a financial crisis occurred in 2008 rather than in earlier years.

e. Could the United States stop funds from flowing in from other
countries? How?
The United States could stop funds from flowing in from other
countries. The Untied States could try to do so directly by
forbidding borrowing from abroad. However the United States would
probably be more successful if it could either decrease the demand
for loanable funds (perhaps by decreasing the government budget
deficit) and/or increase the supply of loanable funds (perhaps
by giving saving a more favorable tax treatment). In this case
the United States could become a net foreign lender of funds.

18. Greenspan’s Conundrum Spells Confusion for Us All

…At the beginning of the year, the consensus was that … bond
yields would rise ... Gradually, over February, the consensus
hasstartedtoreassertitself.…Ten-year Treasury bond yields
were hovering below 4 percent in the early part of the month
but now they are around 4.3 percent. Because the consensus was
that bond yields should be 5 percent by the end of the year,
most commentators have focused, not on why bond yields have
suddenly risen, but on why they were so low before. A number
ofexplanationsforthis“conundrum”havebeenadvanced.First,
 bond yields are being held artificially low by unusual buying.….
Another [is]... bond yields reflect investors’ expectations
for an economic slowdown in 2005.
Financial Times, February 26, 2005
a. Explainhow“unusualbuying”mightleadtoalowrealinterest
rate.
“Unusual buying” means that the demand in the financial market
forbondsis“unusually”large.Inthiscase,theunusuallylarge
demand leads to bond prices being unusually high. Higher bond
prices mean a lower interest rate on the asset. So unusually high
bond prices creates unusually low interest rates on bonds.

b. Explain how “investors’ expectations for an economic

slowdown” might lead to a lower real interest rate.
Investors’ expectations of an economic slowdown mean that the
expected profit from investing in capital falls. The lower
expected profit decreases the demand for investment, which
decreases the demand for loanable funds. The fall in the demand
for loanable funds then lowers the equilibrium real interest rate.

19. Study Reading Between the Lines on pp. 580–581(178-179 in

Macroeconomics) and then answer the following questions.
a. What was the financial rescue package proposed by the
Administration and what was it supposed to do?
The financial package enabled the government to buy the risky
assets (the “toxic assets”) currently owned by financial
institutions. These purchases decreased the risk that financial
institutions would become insolvent. The result of this action
was hoped to be a general decrease in default risk and a restoration
of the normal functioning of the loanable funds market.

b. What did the government hope would occur after the rescue
package was passed?
The government hoped that the loanable funds market would start
to function normally, with loans being more freely made. Longer
term, the government hoped that the supply of loanable funds and
the demand loanable funds would both increase, helping the economy
exit the recession more rapidly.

c. Based on what happened in the stock market, do you think we

can conclude that suppliers of loanable funds believed that
 the rescue package was needed and would work? Explain your
answer.
The stock market fell drastically after the package failed. This
fall suggests that suppliers of loanable funds believed the
package was necessary and would work. Without the package the
supply of loanable funds drastically decreased, driving down the
prices of equities and thereby driving up the real interest rate
paid on these assets. The stock market gained slightly after the
economic bailout package passed in Congress. This fact suggests
that people were more willing to invest in the stock market because
the package decreased the default risk so the supply of loanable
funds increased.

d. What did the government fear would occur if the rescue package
was not passed?
The government feared that both the demand for and supply of
loanable funds would decrease, thereby decreasing the equilibrium
quantity of loanable funds. Then the decrease in loanable funds,
together with the poorly functioning financial market, would drive
the economy into a recession.

e. Again, based on what happened in the stock market, do you think

we can conclude that suppliers of loanable funds shared the
government’s fears? Explain your answer.
The stock market fell drastically after the rescue package failed
to pass in Congress. Based on this result, the suppliers of loanable
seem to have shared the same fear as the government. In the
immediate time after the package initially failed, the supply of
loanable funds decreased, driving down the price of equities, and
driving up the real interest rate. In the longer term, apparently
the suppliers of loanable funds feared that with the economy in
a recession, the risk of default would drastically rise, thereby
decreasing the supply of loanable funds.

f. What other measures might the government take if it wants to

boost supply and demand in the market for loanable funds?
The two major issues that affect the loanable funds market are
the (vastly) increased default risk and the worry that the U.S.
economy will slide into recession, which lowers expected profit.
The first factor decreases the supply of loanable funds (and makes
lending itself more risky) and the second factor decreases the
 demand for loanable funds. The government might try to combat the
first factor by insuring the return on the risky assets. The
government can try to combat the second factor by taking actions
to help combat a recession.

g. How do you think the global nature of the loanable funds

markets influences how the U.S. market would have responded
to no rescue?
If there was no rescue, the global nature of the loanable fund
market helps limit the change in the real interest rate that might
occur. For example, if the real interest rate in the United States
had risen substantially with no rescue plan, the global nature
of the loanable funds market would have limited the rise that would
have occurred.