Interest rates have been at record low levels since 2008. The most recent normal year in the US economy was 2007, the eve of the onset of the global financial crisis. In 2007, the total amount borrowed in the US loanable funds market was $51 trillion, and the real interest rate was 2 percent a year. Both the demand and the supply of loanable funds include borrowing and lending decisions by households, firms, governments, financial institution) (including private institutions and the Fed), and the rest of the world. By mid-2009, due to the economic recession, expected business profit had fallen which decreased investment from $2.2 trillion in 2007 to $1.5 trillion and the demand for loanable funds by households and υ businesses had decreased sharply. The federal government had launched a massive rescue plan that increased its outlays and demand for loanable funds. Despite the large increase in government demand, the overall demand for loanable funds decreased. The demand by households, businesses, and financial institutions decreased by more than the demand by the federal government increased. By 2013, the demand for loanable funds had overall decreased. On the supply side of the market, the Fed continued to supply large quantities of funds. The Fed’s goal was to lower the interest rate and stimulate investment. By 2013, the supply of loanable funds had overall increased. The real interest rate was 0.5 percent per year and the quantity of loanable funds was $55 trillion.
(a) Use a diagram of the loanable funds market to show the developments between 2007 and 2013. Use the names SLF07, SLF13, DLF07 and DLF13 to denote the Supply-of-Loanable-Funds and Demand-for- Loanable-Funds curves in the years 2007 and 2013. Explain how the curves move and why.
(b) What was the effect of the increase of the supply of loanable funds by the federal government? How would the real interest rate and quantity of loanable funds be in 2013, compared to their values in 2007, without the government intervention?