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IAI Actuarial Core Principles · Business Economics · Role of money and interest rates in the economy

In the loanable funds approach to interest rate determination, which of the following would, other things equal, raise the equilibrium interest rate?

A rise in firms' expected returns on investment raises the demand for loanable funds, shifting the demand curve right and lifting the equilibrium interest rate. More saving, more credit supply, less government borrowing or lower project profitability would all push the rate down.

  1. AAn increase in households' desire to save
  2. BA rise in firms' expected returns on investment, increasing their demand for borrowingCorrect
  3. CA fall in government borrowing
  4. DA fall in the expected profitability of new projects
  5. An increase in the supply of credit by banks

Explanation

In the loanable funds model, the interest rate is set where the demand for funds (investment and government borrowing) equals the supply of funds (saving and credit). Higher expected returns raise firms' demand for funds and shift the demand curve right, pushing the rate up. The other options either increase supply or reduce demand, which lowers the rate.

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