Monday

 

Mostly summarized from Gregory Mankiw’s Principles of Economics, 5th Ed.

PART 9 The Real Economy in the Long Run

Chapter 26 of 36 Saving, Investment, and the Financial System

Section 17 of 25

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In Figure 1, market for loanable funds

· the equilibrium interest rate is 5 percent

· the quantity of loanable funds demanded = quantity of loanable funds supplied = $1,200 billion

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If the interest rate became lower than equilibrium level, e.g. 4%, quantity of loanable funds supplied would be less than quantity of loanable funds demanded.

The resulting loanable funds shortage would force a higher interest rate.

The new higher interest rate, back at the equilibrium rate of 5%, would

· encourage saving, increasing quantity of loanable funds supplied

· discourage borrowing, decreasing quantity of loanable funds demanded

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Conversely, if the interest rate became higher than the equilibrium level, e.g. 6%, quantity of loanable funds supplied would be more than the quantity of loanable funds demanded.

The resulting loanable funds surplus would force a lower interest rate.

The new lower interest rate, back at the equilibrium rate of 5%, would

· encourage borrowing, increasing quantity of loanable funds demanded

· discourage saving, decreasing quantity of loanable funds supplied

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Fundamentally in any market :

A lower price (here the interest rate)

· increases amount demanded

· decreases amount supplied

· until settling at an equilibrium price

A higher price

· decreases amount demanded and

· increases amount supplied

· until settling at an equilibrium price

In both cases, the interest rate

· moves toward and settles at the equilibrium level

· the level at which supply and demand for loanable funds balance

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We must distinguish between real interest rate and nominal interest rate.

The nominal interest rate is the stated percent return to saving and cost of borrowing.

The real interest rate is the nominal interest rate corrected for inflation.

Real interest rate = nominal interest rate - inflation rate.

The supply and demand for loanable funds depend on the real, not nominal, interest rate.

For example, the nominal interest rate is 7%, the inflation rate is 2%, so real interest rate is 5%.

The Figure 1 equilibrium interest rate of 5% is the real interest rate.

In the simplified model being used here, the term interest rate refers to real interest rate.

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nominal interest rate and real interest rate

meimoku kinri to jisshitsu kinri

名目金利と実質金利

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When economists mention the current “interest rate,” what interest rate are they referring to? ChatGPT:

When economists mention “the current interest rate” without further explanation, they are usually referring to a benchmark policy interest rate set or guided by the central bank, because it influences borrowing costs throughout the economy.

In the United States, this most often means the federal funds rate, the overnight rate at which banks lend reserves to one another, targeted by the Federal Reserve System.

Economists use it as shorthand for broader financial conditions since changes in this rate tend to affect mortgage rates, business loans, credit cards, savings yields, investment spending, and overall economic activity, even though consumers rarely borrow directly at the federal funds rate itself.

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What is the current U.S. interest rate? CGPT:

The Federal Reserve’s target federal funds rate is currently 3.50%–3.75%, with a midpoint of about 3.625%.

This is the benchmark overnight lending rate between banks and serves as the foundation for many other borrowing costs in the economy, influencing mortgage rates, business loans, credit cards, and savings yields, even though consumers do not borrow directly at this rate.

The Fed has kept this target range unchanged since late 2025

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How does the Federal Reserve set the interest rate? CGPT:

The Federal Reserve uses monetary policy tools, primarily—

-changing interest rate paid on bank reserves

... ...

The Federal Reserve’s target federal funds rate - list this rate for the last twenty years on January 1. CGPT:

2026 3.50% – 3.75%

2025 4.25% – 4.50%

2024 5.25% – 5.50%

2023 4.25% – 4.50%

2022 0.00% – 0.25%

2021 0.00% – 0.25%

2020 1.50% – 1.75%

2019 2.25% – 2.50%

2018 1.25% – 1.50%

2017 0.50% – 0.75%

2016 0.25% – 0.50%

2015 0.00% – 0.25%

2014 0.00% – 0.25%

2013 0.00% – 0.25%

2012 0.00% – 0.25%

2011 0.00% – 0.25%

2010 0.00% – 0.25%

2009 0.00% – 0.25%

2008 4.25%

2007 5.25%

Note: The Federal Reserve began announcing target ranges only in December 2008. Before that, it used a single target federal funds rate.