Global loanable funds market

How Global Loanable Funds Work

Since lenders and borrowers have the freedom to lend and borrow at any country, they both have objectives:

Goal of the Lender (Supplier): is to look for anywhere in the world that has the highest possible interest rate.

Goal of the Borrower (Demand): is to look for anywhere in the world that has the lowest possible interest rate

A country’s loanable funds is associated with the global loanable funds market through net exports.

1. If a country’s net exports are positive ($X$>$M$), this means the country is lending to the rest of the world. The country supplies funds to the rest of the world that is less than their national savings.
2. If a country’s net exports are negative ($X$<$N$), this means the country is borrowing from the rest of the world. The rest of the world supplies funds to the country, which is greater than their national savings.

Demand & Supply for Global Loanable Funds

Demand Curve for Global Loanable Funds: the sum of the demands of loanable funds in all countries, labelled as $DLF_{w}$.

Supply Curve for Global Loanable Funds: the sum of the supplies of loanable funds in all countries, labelled as $SLF_{w}$.



Note: The intersection of the two curves is where the demand and supply of loanable funds are the same and gives the world equilibrium interest rate.

International Borrowers & Lenders

International Lenders: Suppose a country’s net exports are positive ($X$>$M$), and $SLF_{D}$ & $DLF$ are the supply and demand of loanable funds for the country.



If the country is isolated from the world, then the real interest rate would be 3% a year.

If the country is integrated into the global economy, then lenders would want to lend to the rest of the world, rather than their own country due to a higher interest rate. The country faces the supply curve $SLF$, and the excess supply of loanable funds goes to other countries.

International Borrowers: Suppose a country’s net exports are negative ($X$<$M$), and $SLF_{D}$ & $DLF$ are the supply and demand of loanable funds for the country.



If the country is isolated from the world, then the real interest rate would be 5% a year.

If the country is integrated into the global economy, then borrowers would want to borrow from the rest of the world, rather than their own country due to a lower interest rate. The country faces the supply curve $SLF$, and the shortage supply of loanable funds is made up from borrowing from other countries.